**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

### **FORM 10-K**

### ** **

| **ý**                                            | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE**     |
|-------------------------------------------------------|--------------------------------------------------------------------|
| **SECURITIES  EXCHANGE ACT OF 1934**                  |
| ** **                                            |
| **For the  fiscal year ended December 31, 2004** |
|                                                  |                                                               |   |
| **OR**                                                |
|                                                  |                                                               |
| **o**                                                 | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE** |
| **SECURITIES  EXCHANGE ACT OF 1934**             |

 

**For thetransition period from                      to                      .**

 

**CommissionFile No. 000-30617**

 

**GlobalSCAPE,Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                      | ** ** | **74-2785449**                         |
|-------------------------------------------------------------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization)  |       | (I.R.S.  Employer  Identification No.) |
|                                                              |       |                                   |
| **6000 Northwest Parkway, Suite 100  San Antonio, Texas**         |       | **78249**                              |
| (Address of  Principal  Executive Office)                         |       | (Zip Code)                             |
|                                                              |       |                                   |
| **(210) 308-8267**                                                |
| (Registrant’s  Telephone Number, Including Area Code)        |
|                                                              |       |                                   |
| Securities  registered pursuant to Section 12(b) of the Act: |
| **None**                                                          |
| ** **                                                        | ** ** | ** **                             |
| Securities  registered pursuant to Section 12(g) of the Act: |
| **Common Stock, par value $0.001 per share**                      |
| (Title of  Class)                                                 |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

ý  Yes    o  No

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 ofthis chapter) is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.   o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Act).

o  Yes    ý  No

 

The aggregatemarket value of the registrant’s outstanding common stock held bynon-affiliates was approximately $396,321 as of the last business day of theregistrant’s most recently completed second fiscal quarter, based upon theclosing sales price of $0.11 per share on such date on the NASD’s OTC BulletinBoard.  As of March 8, 2005 therewere 13,773,219 common shares outstanding, of which 3,602,909 were held bynon-affiliates.

 

**Documents Incorporated by Reference**

 

Portions of the Registrant’s Proxy Statement for the 2005 AnnualMeeting of Stockholders to be held in June 2005, are incorporated byreference in Part III hereof.

 

 

----

 

**TABLE OF CONTENTS**

 
| **PART I**                         | ** **                                                                                                  |
|------------------------------------|-------------------------------------------------------------------------------------------------------------|
| ** **                         | ** **                                                                                                  | ** ** |
| **Item  1.**                       | **Business**                                                                                                | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 2.**                        | **Properties**                                                                                              | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 3.**                        | **Legal Proceedings**                                                                                       | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 4.**                        | **Submission of Matters to a Vote of Security  Holders**                                                    | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 4A.**                       | **Executive Officers of the Company**                                                                       | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **PART II**                        | ** **                                                                                                  |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 5.**                        | **Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity** | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 6.**                        | **Selected Financial Data**                                                                                 | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item  7.**                       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operation**              | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 7A.**                       | **Quantitative and Qualitative Disclosures About Market Risk**                                              | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 8.**                        | **Financial Statements and Supplementary Data**                                                             | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 9.**                        | **Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure**                   | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 9A.**                       | **Controls and Procedures**                                                                                 | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 9B.**                       | **Other Information**                                                                                       | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **PART III**                       | ** **                                                                                                  |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 10.**                       | **Directors and Executive Officers of the  Registrant**                                                     | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 11.**                       | **Executive Compensation**                                                                                  | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 12.**                       | **Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters**         | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 13.**                       | **Certain Relationships and Related  Transactions**                                                         | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item 14.**                       | **Principal Accountant Fees and Services**                                                                  | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **PART IV**                        | ** **                                                                                                  |
| ** **                         | ** **                                                                                                  | ** ** |
| **Item  15.**                      | **Exhibits,  Financial Statement Schedule**                                                                 | ** ** |
| ** **                         | ** **                                                                                                  | ** ** |
| **Signatures  and Certifications** | ** **                                                                                                  |

 

----

###### ** **

###### **Preliminary Notes**

###### ** **

GlobalSCAPE®, CuteFTP®,CuteSITE Builder®, PureCMS®, CuteZIP®, CuteHTML® and CuteMAP® are registeredtrademarks of GlobalSCAPE Texas, LP.  GlobalSCAPE Secure FTP Server,GlobalSCAPE Transfer Engine, ContentXML and SnapEdit are trademarks ofGlobalSCAPE Texas, LP.  Other trademarks and tradenames in this AnnualReportt are the property of their respective owners.

 

In May 2000,our board of directors approved a 7.6 for 1 stock split.  All information in this Annual Report hasbeen adjusted to reflect the effects of this stock split.

 

###### **Forward-LookingStatements**

###### ** **

This AnnualReport on Form 10-K and the documents incorporated by reference herein contain “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities and Exchange Act of1934, as amended.  “Forward-lookingstatements” are those statements that are not of historical fact, but describemanagement’s beliefs and expectations. We have identified many of the forward-looking statements in this AnnualReport by using words such as “anticipate,” “believe,” “could,” “estimate,” “may,”“expect,” and “intend.”  Although webelieve these beliefs and expectations are reasonable, our operations involve anumber of risks and uncertainties, including those described in the “RiskFactors” section of this Annual Report and other documents filed with theSecurities and Exchange Commission. Therefore, GlobalSCAPE’s actual results could differ materially fromthose discussed in this Annual Report.

 

# **PART I**

#  

##### **Item1. Business**

##### ** **

###### **Company Overview**

###### ** **

GlobalSCAPEdevelops and distributes Internet related software, including file management,content management and Web development tools.*** ***Westarted in 1996 with the distribution of CuteFTP and have achieved significantsuccess and popularity with this product. We built on this success by steadily adding complementary products andbelieve we now have a reputation as a provider of easy-to use, affordablesoftware.  Since 2000 we have focused onenhancing our portfolio of products to meet the increasing demand for datasecurity, and for solutions that permit non-technical personnel to contributecontent to their organizations’ Web sites. Our software is used worldwide across a wide range of industries.  We have sold approximately 1,200,000 softwarelicenses to date and our customer base includes individual consumers, small tomedium-sized businesses, as well as some of the largest corporations in theworld.

 

We distributeour software primarily via download from our Web site, **www.globalscape.com**. Prospective buyers mayuse our software products for free for a thirty-day evaluation period.  The programs are automatically disabled if alicense is not purchased by the end of the trial period.  Our current products range in price from$19.95 to $25,000 per license. Historically, the majority of software purchases have been made onlineusing a credit card.  During 2003 and2004 we increased our emphasis on developing our internal sales staff andreseller channels to capture those sales that require personal attention, suchas sales of our more complex products and sales to larger enterprises.  Our software is also available for downloadfrom a variety of independent Internet software sites such as CNet’sDownload.com, as well as sites in Western Europe, Canada, Australia, andAsia.  We distribute a limited number ofcopies on CD in Fry’s and Micro Center stores in the United States and throughnumerous international resellers.  Weprovide free customer support via a searchable knowledge base on our Web siteand sell “live” support and maintenance packages.

 

1

----

 

During 2004approximately 64% of our revenues were generated from customers within theUnited States, with the remaining 36% concentrated mostly in Western Europe,Canada and Australia.  Virtually all ofour 2004 revenues were derived from sales of software licenses and supportagreements.  The combined sales ofCuteFTP and CuteFTP Pro accounted for 75% and 69% of our revenues in 2003 and2004, respectively.

 

###### **Products**

###### ** **

Our currentproducts include Windows®-based, browser-based and server softwareapplications.

 

***CuteFTP*.**  CuteFTP is a file transfer protocol, or “FTP”,client.  Although the term “FTP” is not ahousehold word, the protocol is well known and heavily used in the informationtechnology world.  Like the more widelyknown “HTTP” that underlies the World Wide Web, FTP is simply a protocol thatallows computers to exchange information over the Internet or othernetworks.  CuteFTP is a “client-side”program, meaning that it permits a user to request a file from or send a fileto an FTP server or host computer.  Theuser base for this program ranges from corporate MIS professionals who use itto transfer data between locations via the Internet, to individual Web siteoperators who use it to upload their Web pages to their Web hostingprovider.  CuteFTP simplifies use of filetransfer protocol by hiding the technical processes behind a user-friendly,graphical interface, which allows users to “drag `n drop” files betweencomputers.  It includes an automaticreconnection feature that resumes broken transfers, a transfer queue and abuilt in HTML editor that allows remote editing of Web pages.  CuteFTP has won several awards, including theCNet Editors’ Choice award, and has been favorably reviewed in leading onlineand print trade journals such as PC Magazine, WindowsNT, Yahoo Internet Life,CNet’s Download.com and Tucows, as being the most powerful, easy-to-use filetransfer protocol program available.  Weoffer CuteFTP in German, French, Spanish, Japanese and Traditional andSimplified Chinese.  CuteFTP was firstreleased in February 1995 by its original author, and was firstdistributed as a commercial product by GlobalSCAPE in April 1996.  In October 2003 GlobalSCAPE releasedCuteFTP Mac, our easy-to use ftp client for the Macintosh operatingsystem.  CuteFTP Mac incorporates many ofthe popular features of CuteFTP for Windows, while adhering to Apple’s Aqua®interface and usability guidelines.

 

***CuteFTP Pro*.**  CuteFTP Pro is a secure FTP client designedfor advanced users and information technology professionals.  CuteFTP Pro incorporates standards forencrypted transfers using Secure Socket Layer (SSL), HTTP, and SSH2, as well asadvanced S/KEY password encryption.  Itincludes various features attractive to advanced users such as multi-part andconcurrent file transfers to maximize transfer speed, scheduled file transfers,automated site backups and scripting ability for automating FTP tasks.  CuteFTP Pro has been favorably reviewed byleading online publications including CNet’s Download.com, ZDNet and PCReview.  CuteFTP Pro was released in March 2001.

 

***Secure FTP Server*.**  Secure FTP Server complements CuteFTP Pro andother professional FTP clients by enabling encrypted transfers using SecureSocket Layer (SSL), Secure Shell (SSH2) and advanced S/KEY passwordencryption.  When used with CuteFTP Pro,Secure FTP Server offers a complete digital certificate management system,giving system administrators the ability to create, sign, import, export andadd digital certificates, as well as kick off back-end processes. The latterfunctionality can be used as a partial or total replacement for more complexenterprise-level electronic data interchange systems (EDI).  Additional features include full remote managementcapability, the ability to operate multiple FTP sites with unique directorystructures from a single server and manage user accounts with advancedrestriction settings for maximum security and control.  Secure FTP Server has been favorably reviewedby leading online publications including Server Watch and File Forum.GlobalSCAPE Secure FTP Server was first released in January 2002.

 

***Enhanced FileTransfer Server.***Enhanced File Transfer Server isa hardened file server for enterprise-level solutions. Building on Secure FTPServer with digital certificate management, Secure Socket Layer (SSL) and S/KEYpassword encryption, remote administration, multiple site hosting andmanagement, and extensive automation with a full featured event rule libraryand Component Object Model (COM) extensions, Enhanced File Transfer Server addsrepository encryption, additional protocol

 

2

----

 

support, SSH security, data offload capabilities, and automatednotification. Enhanced File Transfer Server was first released by GlobalSCAPEin November 2004.

 

***CuteSite Builder***.  CuteSITE Builder is a WYSIWYG (what you seeis what you get) Web site creation tool enabling anyone, regardless of skilllevel, to easily create, publish and manage a high quality Web site withouthaving to learn HTML, FTP or graphic design. Users choose the design and type of Web site they would like to createfrom professionally designed templates, add personalized content such as familyphotos, images and links and publish their Web site with just one click.  This program is based on technology licensedfrom Trellix Corporation and previously distributed as Trellix Web.  CuteSITE Builder was first released byGlobalSCAPE in June 2001.

 

***SnapEdit.*** SnapEditis the easiest, most affordable way to enable non-technical users tocreate and publish information to a Web site, in real-time. Thissimplified Web content management (WCM) system works with any sharedor dedicated hosting environment and can be installed quickly by Website administrators.  End users simply browse to the Website and create or edit any type of information imaginableincluding tables, images and media files through SnapEdit’sWhat-You-See-Is-What-You-Get (WYSIWYG) editor and file manager. Plus, withSnapEdit’s automatic backups and protective editing features, you won’t worryabout losing content or unauthorized content being changed. SnapEdit wasfirst released by GlobalSCAPE in July 2004.

 

***PureCMS***.  PureCMS is our Web content managementsolution.  “Content management” generallyrefers to software that streamlines the process for managing information on aWeb site or intranet.  PureCMS isdesigned to solve basic problems endemic to maintaining current information ona Web site such as bottlenecks in the IT department, lack of control andaccountability, and miscommunication between content authors and Webdevelopers.  Using PureCMS, a company’sWeb administrator may give non-technical personnel the ability to directlyrevise designated content.  For example,the marketing department could modify pricing, product descriptions andgraphics while the human resources department updated its job postings, allwithout the involvement of technical personnel. Access by non-technical personnel is limited, however, so that the Website administrator’s ability to protect the overall infrastructure and designof the site is not compromised.  Theprogram is browser-based with a Windows-like interface, so users can easilyaccess and work on Web sites, eliminating the need for special training.  Changes are made to a copy of an organization’sWeb site in a staging area and published to the live site only after groupleaders or Web site administrators approve the content for publishing.  Additional features include WYSIWYG (what yousee is what you get) editing, visual comparison of proposed changes to the livesite, e-mail notification of changes and activity, site statistics, versioningand archiving.  PureCMS works with any Website development tool including popular applications such as Front Page andDreamweaver, and can be implemented without deconstructing (re-building) theexisting Web site.  The program is scaledto meet the needs of small to medium-sized businesses, but can be used by largeorganizations for intranet or independent Web site management.  PureCMS was released in January 2003.

 

In January 2004we also made the software available as an application service model. We hostthe software for use on our servers in exchange for a periodic fee, rather thanlicensing a copy to the customer for use on the customer’s server.

 

***Web Survey***.  Web Survey is an easy-to-use program forconducting surveys on Web sites.  Usersmay design and publish questionnaires and gather results in their e-mailin-box, without the need for custom programming.  The program includes tools for the analysisand presentation of results.  Web Surveywas released in May 2003.

 

***CuteZIP*.**  CuteZIP is a file compression program thatenables users to shrink and encrypt files for secure transfer and storage using“strong” or 128-bit encryption.  Usersmay compress files across multiple disks or within a directory for easydownload or storage.  Users may alsocreate encrypted self-extracting files that may be opened by a recipientwithout the use of a zip utility. CuteZIP has won the CNet Editors’ Choice award and has been favorablyreviewed by leading online publications such as CNet’s Download.com, MP3.comand Tucows.  CuteZIP was first releasedin September 1999.

 

3

----

 

***CuteHTML*.**  CuteHTML is a text-based HTML (hypertextmarkup language) editor used to create Web pages.  CuteHTML is a direct editing**tool, meaning that the user creates andedits HTML code directly, as opposed to a visual editing or WYSIWIG tool like CuteSITEBuilder, which does not require the user to understand HTML coding.  It includes various productivity enhancingfeatures such as color coded tags for easy code identification, tag tips forquick access to standard HTML tags, multiple document find and replace, spellcheck, code for individual browsers, tabbed interface and the ability to editfiles on remote servers when used in conjunction with CuteFTP.  CuteHTML has been favorably reviewed inleading online and print publications including CNet’s Download.com, ZDNET andTucows.  CuteHTML was first released in January 1999.

 

***CuteHTML Pro***.  CuteHTML Pro is our professional Web editingtool, offering Web masters even more control over Web projects, code and sitequality.  Code created with CuteHTML Promeets strict HTML specifications, such as those defined by the Word Wide WebConsortium, and does not add extraneous or non-standards compliant code.  CuteHTML Pro includes features attractive toadvanced users of HTML editors, such a comprehensive Script Generator, hundredsof ready-to-use Java and DHTML scripts, extended string/paragraph Search &Replace, inline Perl and PHP parser, built in FTP module, Document Evaluation,and a robust multi-language Reference Editor. In addition, Web masters can quickly generate complex code such astables, frames, image maps, forms and text formatting with wizard-like dialogs,recall commonly used code snippets using a single keystroke sequence, andcreate pages using one of the many pre-built page templates.  The software also includes project controlfeatures such as built in File, Project, To-Do List and Bookmark Managementtools, and permits users to easily check spelling, optimize code, validatelinks and check CSS, HTML, and JavaScript Syntax for error free sites.  In addition, the software permits users topreview HTML pages without launching an external browser and highlights syntaxfor Perl, XML, WML, ASP, PHP, ColdFusion, CSS, and JavaScript languages.

 

***CuteMAP***.  CuteMAP is an image-mapping tool designed tohelp HTML users create clickable images on their Web site graphics for improvednavigation.  Users select the area of animage that they want “hot,” and tell CuteMAP where the image should point.  CuteMAP automatically creates the image map code,which can be copied to an existing HTML document.  CuteMAP has been favorably reviewed inleading online and print publications including CNet’s Download.com, ZDNET,Tucows and LockerGnome. CuteMAP was first released in September 1999.

 

In December 2003,we released Protect IIS, an application firewall for use in securing MicrosoftIIS Web Servers from Internet based attacks. We received only lukewarm response to this program, and decided in February 2004to discontinue distribution.  The programwas licensed to us on a trial basis by Turillion Software Technologies, Inc.,so we experienced minimal costs in developing and launching the program.

 

We alsodiscontinued our Web Hosting product in 2003 after experiencing disappointingsales results.  The service was providedon a trial basis by FortuneCity.com, Inc., so we experienced minimal costs indeveloping and launching this service as well.

 

###### **History and RecentDevelopments**

###### ** **

GlobalSCAPE wasorganized as a Delaware corporation in April 1996 when we obtained theright to distribute CuteFTP from its original author.  Our former parent, ATSI Communications, Inc.(ATSI), established GlobalSCAPE as a wholly owned subsidiary dedicated to thedevelopment, marketing and support of Internet software products and theexecution of other strategies unrelated to ATSI’s core telecommunicationsbusiness.  In 1998, we purchased allrights to CuteFTP from its author and in 1999 began developing and sellingcomplementary products under the “Cute” brand such as CuteHTML andCuteMAP.  In September 2000, ATSIdistributed approximately 27% of its GlobalSCAPE common stock to itsshareholders.  As a result of thispartial spin off, we became a reporting company under the Securities ExchangeAct of 1934.  In June 2002, ATSIsold its remaining interest in the company to a San Antonio-based jointventure.

 

4

----

 

Significantrecent developments are as follows:

 

**•**                  **January 2004**:  Weannounced the availability of PureCMS as a hosted content management service.

 

**•**                  **January 2004**:  Thefederal General Services Administration approved GlobalSCAPE as a governmentsupplier via the award of a five-year contract under the multiple award schedule program.  This approval enables government agencies topurchase GlobalSCAPE’s software without completing the cumbersome procurementprocedures required for non-scheduled suppliers.

 

**•**                  **February 2004**:  SandraPoole-Christal stepped down as President and Chief Operating Officer and wassucceeded as President by Charles R. Poole. Ms. Poole-Christal will continue to serve as the Company’s VicePresident of Marketing.  Ms.Poole-Christal also resigned her seat on the Board of Directors, and Mr. Poolewas elected to complete her term by the remaining Board members.  Along with the change in management, theCompany laid off 9 employees, approximately 20% of its workforce, as part of anexpense control measure.

 

**•**                  **March 2004**:  Wereleased our Secure FTP Server 2.0 an enterprise-class FTP server for thesecure transfer and management of critical business data.

 

•                  **March 2004**:  We released newCuteFTP 6.0 Home and Professional versions.

 

**•**                  **April 2004**:  Weannounced the availability of PublishXML, which offers businesses a way to manage Web content with sophisticated, enterpriseclass features.

 

**•**                  **April 2004**:  Weannounced new channel partner program including lead generation, sales andmarketing support, technical training, partner discounts and access to onlineresources.

 

**•**                  **June 2004**:  DanielMcRedmond resigned his position as Vice President of Finance and Operations andwas replaced by Thomas F. Farar as Chief Financial Officer.

 

**•**                  **July 2004**:  Wereleased PureCMS 3.0, our mid-market browser based content management software.

 

**•**                  **July 2004**:  Weannounced the availability of SnapEdit, an entry level content managementsoftware tool, adding to our  existingline of content management products.

 

**•**                  **August 2004**:  Weannounced the availability of CuteFTP Server, allowing individuals to hosttheir own FTP server from home.

 

**•**                  **November 2004**:  Weannounced availability of our Enhanced File Transfer (EFT) solution providingincreased security, reliability and automation for improved enterpriseinformation management.

 

**•**                  **February 2005**:  Weannounced availability of our EFT product at the HIMMS trade show forhealthcare organizations.

 

###### **IndustryBackground**

###### ** **

The Internethas become an integral part of operations for companies of all sizes, not onlyfor e-commerce, but also as a means of managing information between central andremote locations and with employees, partners and suppliers.  We believe that the Internet will continue togrow and that this growth will continue to create demand for our products.  As corporate Web operations mature, webelieve we will

 

5

----

 

see an increasing demand forsolutions to facilitate secure file transfers on the internet and for solutionsthat streamline the management of Web content.

 

###### **Strategy**

###### ** **

Our goal is tobuild upon our successful market position in FTP (file transfer protocol) forthe past 9 years in order to provide large users with very secure solutions totheir growing file transfer needs. We continue to enhance high quality,affordable software that enables organizations and individuals to easily create,move and manage Web and file-based data in a secure, collaborativeenvironment.  We have successfullyestablished a brand in the market for Internet software productivity tools withour file management products, CuteFTP and CuteFTP Pro.  We believe the next phase of our growth willcome through the provision of our products involving secure file transfer tomeet the growing demand for file security when transferring information acrossthe internet due to changes in regulations in various industries and contentmanagement solutions that help non-technical professionals manage theirorganization’s Web sites without reliance on information technologyprofessionals.

 

Key elementsof our strategy are:

 

***Continue to enhanceand develop security features of our products. ***Corporate and individual users areincreasingly concerned with security.  Wehave added the Enhanced File Transfer (EFT) enterprise solution to our productline as a solution for businesses to meet the needs of security issues whentransferring files in and out of their servers across the internet. We willcontinue to develop and add features throughout 2005 to meet the demand forfile transfer security in EFT and our other well known FTP products, CuteFTPHome and CuteFTP Professional. We intend to make the FTP and EFT lines ofbusiness our main focus in 2005.

 

***Continue  sales of PureCMS. ***We have investedconsiderable funds and effort in both the development and marketing of PureCMS,our content management product introduced in January 2003. Although wehave been disappointed with our sales of this program to date, we continue tobelieve that the demand for Web content management solutions is strong.  We have released new versions of this productand continue to evaluate all aspects of our management of this product,including pricing, ease of installation and use, program functionality, andmarketing and sales strategies.  Weintend to continue to  pursue sales anddistribution of this product.  Theproduct launch and the related selling and development activities for PureCMSconsumed a significant portion of our financial resources in 2003. In 2004 wecontinued to develop and market this product with significantly lessexpenditures.

 

***Develop a morerobust reseller channel*.**  During 2004 we continued our emphasis on thedevelopment of our third party reseller channels, and we are continuallyworking on this effort. In particular, we wish to reach “value-added” resellerssuch as Web design consultants.  Webelieve sales will be significantly enhanced if we are able to recruit numerousresellers who have existing relationships with prospective customers.

 

***Develop our internal sales staff****.* During 2004 we continued the development of our internal direct salesforce to better sell our more complex products, such as Enhanced File Transfer,PureCMS, Secure FTP Server and PublishXML. We intend to continue to develop oursales staff through further training and certification.

 

***Continue to developonline marketing capabilities****. *Webelieve we have significant expertise in driving online sales via onlinemarketing activities, including product placement on third party sites such assearch engines and referral sites, and electronic mail campaigns.  This type of sales activity is particularlywell suited to certain of our lower priced products because of the lower costof sale.  We intend to continue toleverage our established Web presence to drive online sales as well assupporting our direct and reseller sales efforts.

 

6

----

 

***Pursue strategicproduct opportunities*.**  In 2004 we added PublishXML, SnapEdit andEnhanced File Transfer to our product portfolio.  We will continue to look for opportunities toacquire or add synergistic products or technologies that enhance the onlinemanagement of Web and file based data to our portfolio.

 

###### **Seasonality**

###### ** **

We believe our sales aresubject to seasonal variations and we experience significantly less salesvolume during national holidays and weekends when compared to normal businessdays.  In 2000, we experienced a declinein software sales from the third to fourth quarter, primarily due to lower December sales.  Third and fourth quarter revenues in 2001were comparable, however, we believe this was the result of unusually weakdemand in September which skewed the comparison.  In 2002, fourth quarter revenues wereslightly higher than the third quarter due to a fourth quarter upgrade releaseof CuteFTP Pro that bolstered revenues for the period.  In 2003, fourth quarter sales were 19% lowerthan third quarter sales primarily due to weakness in November andDecember, although it is not clear that the decline was due solely to seasonalfactors as turnover in our sales force may also have contributed to the declinein revenues.  In the fourth quarter of2004, our sales revenues increased approximately 11% over the same period in2003, as a result of new product releases and our sales force development.Sales did decline from November 2004 to December 2004. We expect thatin future periods we will see weakness in the fourth quarter when compared tothe third quarter due to the holiday season.

 

###### **Network andEquipment**

###### ** **

We havecontracted with various network providers for Internet access.  Our arrangements provide for redundancy inthe event of a failure, and also for rapid expansion of available bandwidth inthe event that there is a dramatic increase in demand.  To protect critical customer data,GlobalSCAPE’s secure server utilizes Secure Sockets Layer encryption.  We have dedicated servers on and off site andexpansion plans in place to allow rapid and cost effective scalability.

 

###### **Research andDevelopment**

###### ** **

Our internalsoftware engineers are responsible for software design, managing thedevelopment process, testing and quality assurance. We utilize offshoredevelopers for a large portion of the coding phase of softwaredevelopment.  All phases of development,including scope approval, functional and implementation design, object modelingand programming, are subject to internal quality assurance testing.  Our use of external developers allows us totap into a highly skilled labor pool, maintain a 24-hour development schedule,decrease time to market, and minimize programming costs.

 

For the years2002, 2003 and 2004 GlobalSCAPE spent approximately $848,000, $945,000 and$728,000 respectively, on research and development.  No research and development costs werecapitalized in 2002, 2003 or 2004 and all previously capitalized developmentcosts were fully amortized at December 31, 2002.

 

###### **Competition**

###### ** **

The filemanagement, content management and Web development software market sectors areintensely competitive, subject to rapid change and are significantly affectedby new product introductions and other activities of market participants.  Our primary competitors vary by product andare listed below.

 

***CuteFTP*.**  CuteFTP exists in a highly competitiveenvironment with several hundred FTP software utilities available on theInternet. We believe our primary competitors are WS_FTP from Ipswitch, Inc. andFTP Voyager by Rhino Software, Inc. CuteFTP was the second Windows-based FTP client to market and isconsistently the most frequently downloaded FTP client on popular downloadsites.  CuteFTP Mac, our FTP client forthe Macintosh platform competes with Fetch, by Fetch Softworks, Interachry, by Stairways Software Pty Ltd., and Transmit FTP,by Panic Inc.

 

***CuteFTP Pro*.**  CuteFTP Professional competes in the higherend of the same market as CuteFTP, targeting the security minded ITprofessional.  CuteFTP Professional ispositioned as one of the only secure

 

7

----

 

FTP clients that support a wide range of security standards related tothe FTP protocol.  Competitors in thegeneral FTP market offer products that support a smaller subset of thesesecurity standards and address a narrower segment of the secure FTPmarket.  Competitors include Van Dyke,Inc., Ipswitch, Inc., and Rhino Software, Inc.

 

***Secure FTP Server***.  Secure FTP Server competes against a limitednumber of secure Windows-based FTP servers. We believe our primary competitors are WS_FTP Server and Serve-U.  Secure FTP Server has the advantage ofleveraging the success of CuteFTP Pro through product integration, offeringproprietary extensions to the FTP protocol, and cross-marketing efforts to anexisting customer base.

 

***Enhanced FileTransfer Server.***Enhanced File Transfer Servercompetes in the managed file transfer server market. We believe our primarycompetitors are Tumbleweed, Sterling, Proginet, and SSH’s Tectia. Enhanced FileTransfer Server has the advantage of being very cost effective in its marketwhile leveraging and extending the security and file management features of ourother FTP products.

 

***CuteSITE Builder***.  CuteSITE Builder competes against approximatelyone hundred WYSIWYG editors, including MS FrontPage, Macromedia’s Dreamweaver,HotMetal and HotDog.  CuteSITE Builderoffers most of the features available in FrontPage, however, the product wasdeveloped to further simplify the Web site creation process and is arguablyeasier to use, better serving the novice. In addition, the product is priced well below FrontPage.

 

***PureCMS***.  The “content management” market is diverseand encompasses the areas of knowledge management, document management, digitalasset management and Web content management. PureCMS is designed for Web content management.  The market for Web content managementsolutions for Fortune 500 companies and other large organizations is dominatedby companies such as Vignette, Interwoven, Documentum, Stellant and Microsoft,each of which offers solutions that can cost hundreds of thousands ofdollars.  We do not intend to compete inthis market but are focused on small to medium-sized businesses with a simpler,affordably priced solution.  We believethat we have a competitive advantage in that we are better known than some ofour competitors among technology professionals who are already familiar withour file management programs, CuteFTP and CuteFTP Pro.

 

We offerPureCMS both as a packaged solution and as an online service over theInternet.  A “packaged solution” meansthat we license a copy of the software to the customer for a one-time fee toinstall and use on their own servers.  Ifa customer elects to use PureCMS as a service, they access the software onGlobalSCAPE’s servers via the Internet and pay a monthly or other periodicfee.  Our competitors include providersof online solutions, such as Atomz, Crown Peak, and iUpload, and providers ofpackaged solutions, including Macromedia’s Contribute, Userland, Infosquare andEktron.  We believe that by offeringPureCMS both as a service and a packaged solution we can capture thosecustomers who prefer to have control over the solution rather than an ongoingdependency on a technology provider, as well as those customers who prefer topay a monthly or other periodic fee rather than a higher one-time license fee.

 

PureCMS alsocompetes against software that incorporate subsets of Web content managementfunctions in Web authoring programs, such as Microsoft’s FrontPage, andMacromedia’s Dreamweaver and Contribute.

 

***Web Survey. ***Competitiveproducts include both applications and services including Zoomerang,WebSurveyor, EZSurvey and SurveyMonkey. We believe Web Survey has an advantage of a lower total cost ofownership than the competition.

 

***CuteHTML*.**  CuteHTML exists in a highly competitiveenvironment with approximately one hundred text-based HTML editors. CuteHTML’scompetition includes HomeSite from Allaire, Inc. CuteHTML’s advantage is that itdoesn’t add extraneous code to Web pages, an attribute preferred by manyprofessional Web masters.

 

8

----

 

***CuteHTML Pro***.  CuteHTML Pro faces heavy competition fromvisual or “WYSIWYG” editors such as Front Page, by Microsoft, Dreamweaver, byMacromedia Inc, and competition from other direct editors*,*such as Homesite, also by MacromediaInc.  CuteHTML Pro’s advantage is itsappeal to professional Webmasters who typically shun visual editors in favor ofthe extra features and added control provided by direct editors such asCuteHTML Pro

 

***CuteMAP*.**  CuteMAP competes against approximately 65image-mapping utilities, which exist in a niche market.  Primary competitors include CoffeeCup ImageMapper, Ulead Smart Saver and MapEdit. CuteMAP has the advantage of being ableto leverage the success of CuteHTML through product integration andcross-marketing efforts to an existing customer base.

 

***CuteZIP*.**  CuteZIP exists in the highly competitive filecompression utility market, competing against several hundred file compressionutilities. Its main competitors include WinZIP, the current market leader, andNetZIP.  CuteZIP’s main advantage is thatit is one of the only compression utilities offering 128-bit encryption tosecure compressed files.  In addition,users can create self-extracting encrypted archives that recipients may openeven if they don’t have a zip utility installed.

 

We havelimited information regarding our products’ market shares in their respectivecategories. For more discussion on the risks associated with our competition,you should read the information under “Risk Factors.”

 

###### **IntellectualProperty**

###### ** **

Ourtrademarks, copyrights and technology are central to our business.  We protect our intellectual property rightsthrough a combination of licenses, trademarks, service marks, copyrights, tradesecret laws and restrictions on disclosure.

 

We currentlyhave registered trademarks for GlobalSCAPE, CuteFTP, CuteFTP Pro, PureCMS,CuteHTML, CuteZIP, CuteMAP and CuteSITE Builder.  We have obtained United States copyrightregistrations for all but the most recently developed versions of our softwareapplications, and have applied for registration for the most recently developedversions.

 

For morediscussion on the risks associated with our intellectual property, you shouldread the information under “Risk Factors,” especially “Risks Related to LegalUncertainty.”

 

###### **Employees**

###### ** **

As of February 22,2005, we had 39 full-time and part-time employees organized within seven functionalareas.  The employee distributionaccording to function is as follows:

 
| **Department**                | ** ** | **Number of  Employees** |
|-------------------------------|------------|--------------------------|
| Management and Administration |       | 6                        |
| Research and Development      |       | 3                        |
| Quality Assurance             |       | 2                        |
| Marketing                     |       | 8                        |
| Information Services          |       | 4                        |
| Sales                         |       | 10                       |
| Customer Support              |       | 6                        |

 

None of ouremployees are covered by collective bargaining agreements and we believe ouremployee relations are good.

 

###### **Risk Factors**

###### ** **

We havedescribed below risks that we are aware of that could have a material adverseeffect on your stock ownership and our business.

 

9

----

 

Risks Relatedto Operations

 

***GlobalSCAPE depends on two products for a substantialportion of its revenues.***

*** ***

GlobalSCAPEdepends on two products, CuteFTP and CuteFTP Pro, for approximately 69% of itsrevenues.  In addition, GlobalSCAPE’sability to produce revenues related to other products and new products dependssubstantially on exploiting the traffic to GlobalSCAPE’s Web site generated bythe demand for CuteFTP and CuteFTP Pro. If GlobalSCAPE is not able to maintain its competitive position withthese products, its revenues could decline dramatically and GlobalSCAPE’s plansto expand its business could be substantially impaired.  From 1996 to 2000, sales of licenses forCuteFTP increased significantly year to year. In 2002, revenues recognized from CuteFTP and CuteFTP Pro declined fromthe prior year by approximately 7%.  In2003, revenues recognized from CuteFTP and CuteFTP Pro declined from 2002 byapproximately 21%.  In 2004, revenuesrecognized from CuteFTP and CuteFTP Pro declined from 2003 by approximately 7%.This decline was primarily in sales of CuteFTP, which declined 36%.  Sales of CuteFTP Pro increased byapproximately 41% year over year. Substantially all software products ultimately reach a point in theirlifecycle in which sales can be expected to plateau or decline.  While it cannot be determined with certainty,these products may have reached such a point in their lifecycles.

 

***If we do not increase revenues or decrease expenses wewill not be able to continue as a going concern.***

*** ***

The Companyincurred significant operating losses during the three years ending 2003. InJanuary, February and March of 2004, it continued to incursignificant operating losses. In February 2004, GlobalSCAPE laid off 9 ofthe company’s 45 employees to decrease expenses. The Company has improved  its working capital since that time andoperated at a profit for the year ended 2004. If we fail to increase our revenues or decrease expenses, we may not beable to continue as a going concern.

 

***GlobalSCAPE’s newproduct introductions may fail to generate sufficient revenue.***

 

We haveinvested considerable time and financial resources in the development andmarketing of PureCMS, our content management program released in January 2003.  To date we have realized limited revenue fromthis product and will not recoup the expenses of bringing this product tomarket unless sales increase dramatically. We have also experienced disappointing results with our Web hostingservice for PureCMS.  If revenues fromCuteFTP and CuteFTP Pro continue to decline and our new products fail togenerate sufficient revenue to replace the declining revenues, our revenueswill decline.

 

***GlobalSCAPE may failto develop or license the intellectual property needed to launch new products.***

 

Our strategyfor future growth depends significantly on the addition of new products.  If we fail to timely license and/or developnew programs, or if our new programs are not functionally competitive withother programs in this market, our revenue growth could be substantiallyimpaired.

 

***GlobalSCAPE may not be able to develop its sales forceas needed to successfully market its new products.***

*** ***

GlobalSCAPEhas relied heavily on Internet sales in the past.  However, our newer enterprise programs,PureCMS, Secure FTP Server, PublishXML and Enhanced File Transfer (EFT) requirea more complex distribution model, including heavy reliance on value-addedresellers such as Web development consultants. In addition, we must develop an internal sales force that is skilled atmanaging a complex and multi-stage sales process appropriate for theseproducts.  The PureCMS product may notprovide sufficient revenue to offset development and marketing from prior yearscosts if we are not able to successfully implement these changes.  We have experienced significant turnoveramong our internal sales personnel during 2004, possibly as a result of thechanging demands we are placing on our sales staff.  This turnover has had an immediate and directeffect on our revenues.  Continuedturnover, especially of key personnel, could cause revenues to declinedramatically.

 

10

----

 

***If GlobalSCAPE loses key personnel it may not be ableto execute its business plan.***

*** ***

GlobalSCAPE’sfuture success depends on the continued services of key members of its salesteam. GlobalSCAPE has experienced significant turnover in its sales departmentduring 2004, possibly due to changing demands placed on sales personnel as thecompany works toward development of a larger and more skilled sales staff.  These individuals are difficult to replacebecause of the intense competition for similarly skilled people.  In addition, new employees in the sales departmentmay not be productive for weeks or months as they learn about GlobalSCAPE’sproducts.

 

***GlobalSCAPE’s position in the Internet software marketis continuously threatened because the market is intensely competitive andtechnology is constantly changing.***

*** ***

The softwareindustry is characterized by rapid technological change.  GlobalSCAPE’s competitors are constantlyreleasing improved versions of their products. The needs and expectations ofGlobalSCAPE’s customers are also evolving. Therefore, GlobalSCAPE must continually enhance its products and developnew products to remain competitive.  Whena new product is brought to market with functionality better suited to aparticular use, the demand for currently available products may decrease.  All of GlobalSCAPE’s products are subject tothe threat of reduced market share resulting from the introduction ofcompetitive products.  GlobalSCAPE mayfail to develop new products and functionalities as quickly as is necessary inthe future to avoid losing its position in the Internet software market.

 

In addition tostand-alone FTP clients, CuteFTP competes with browsers, open source filesharing communities and download utilities, which provide subsets of the filetransfer protocol functionality.  Thesecompeting products may reduce the demand for CuteFTP.

 

In addition,software development generally requires substantial lead-time, so GlobalSCAPEmust accurately predict what changes will be needed.  GlobalSCAPE may fail to predict these changesfar enough in advance, or it may not have sufficient technical personnel tomake such changes.  If GlobalSCAPE cannotkeep pace, its products will lose their position in the market.

 

***GlobalSCAPE utilizes“open source” software in some of its products.***

 

The opensource software community develops software technology for free use byanyone.  We have relied on open sourcetechnology for the encryption features in our CuteFTP Pro and GlobalSCAPESecure FTP Server products.  For theseproducts to remain competitive, we must continue to enhance their features,including the encryption features.  Ifthe open source community does not continue to develop and enhance theencryption technologies we rely on, we would have to license this technology.  We may have to pay substantial fees for sucha license, and it is possible that we would not be able to license thistechnology on any acceptable terms.

 

***Future governmentregulation may increase our cost of doing business and reduce demand for ourproducts*.**

 

New laws maybe adopted to address areas such as taxation, privacy, copyrights, and qualityof services, and existing laws may be applied to the Internet in unexpectedways.  New laws and unexpectedapplication of existing laws related to the Internet could create uncertaintyin the Internet market place, which could increase our cost of doing business,reduce demand for our products, and have a material adverse effect on ourbusiness, financial condition and operations.

 

***If an effectiveInternet sales tax scheme is implemented, demand for our products could bedecreased.***

 

GlobalSCAPE is not currently required to collect sales tax on itsonline sales except to customers in certain states.  In general, state laws require that if theseller does not collect sales tax, residents who purchase goods online shouldremit sales tax to the appropriate taxing agency in the state where theylive.  However, state agencies rarelyenforce this rule and we believe that less than 1% of our customers actuallyremit sales tax to their state taxing agencies. For practical purposes, most of our customers who do not pay sales taxto

 

11

----

 

us purchase their license on a tax-free basis.  If an effective Internet sales tax scheme isimplemented it would effectively increase the cost of our software in the eyesof our customers and therefore likely have a tendency to decrease demand forour software.

 

***Taxes imposed byforeign governments may decrease demand for our products in those markets.***

 

On July 1,2003, the European Union (EU) enacted Value Added Taxes (VAT) on electronicpurchases.  These taxes are charged toour non-business customers in the EU member nations and rates vary bycountry.  Western European countriesaccount for a substantial portion of our international sales.  These taxes, which vary in rate from 15% to25%, may decrease demand for our products in these markets.  Expansion in the number of the EU membernations may also decrease demand for our products as these taxes are imposed onmore of our customers.

 

***GlobalSCAPE may not be able to compete effectivelywith larger, better-positioned companies, resulting in lower margins and lossof market share.***

*** ***

GlobalSCAPEcompetes with a variety of companies who have significantly greater revenuesand financial resources than GlobalSCAPE as well as greater personnel andtechnical resources.  For example,CuteFTP and CuteFTP Pro compete with products offered by Ipswitch, Inc. andMicrosoft Corporation, PureCMS competes with Macromedia Inc.’s software, andCuteSite Builder competes with Microsoft and Macromedia software.  Large companies may be able to develop newtechnologies more quickly than GlobalSCAPE, to offer a broader array ofproducts, and to respond more quickly to new opportunities, industry standardsor customer requirements.  For example,Macromedia’s Dreamweaver is one of the most popular Web authoring programs forconsumers and small businesses, providing them with a huge established customerbase to which they are able to directly market their content managementproduct, Contribute.  Some competitorsmay also be able to adopt more aggressive pricing strategies.  For example, Ipswitch gives an older versionof its file transfer protocol program away for free for non-commercial use, andMicrosoft includes file transfer protocol functionality in its Internetbrowser, which it distributes for free. Increased competition may result in lower operating margins and loss ofmarket share. Additional competitors may enter the market and may havesignificantly greater capabilities and resources than GlobalSCAPE.  You should read the information under “Business-Competition”for more information on our competitors.

 

***It may be difficult for GlobalSCAPE to recruitsoftware developers and other technical and management personnel becauseGlobalSCAPE is a relatively small company.***

*** ***

GlobalSCAPEcompetes intensely with other Internet software development and distributioncompanies internationally to recruit and hire from a limited pool of qualifiedpersonnel.  Some qualified candidatesprefer to work for larger, better known companies.  Failure to attract and maintain qualifiedpersonnel would impede our development and maintenance of new and existingproducts.

 

***GlobalSCAPE’s ability to develop its software will beseriously impaired if it is not able to use its foreign subcontractors.***

*** ***

GlobalSCAPErelies on foreign subcontractors to help it develop its software.  If these programmers decided to stop workingfor GlobalSCAPE, or if GlobalSCAPE were unable to continue using them becauseof political or economic instability, GlobalSCAPE would have difficulty findingcomparably skilled developers.  Inaddition, GlobalSCAPE would likely have to pay considerably more for the samework, especially if it used U.S. personnel. If GlobalSCAPE could not replace the programmers, it would take itsignificantly longer to develop its products.

 

***GlobalSCAPE may incur losses as it attempts to expandits business.***

*** ***

GlobalSCAPEintends to expand its business and therefore expects to expend significantadditional resources on developing its sales force, developing a more robustreseller program, research and development, marketing and productdevelopment.  As a result, GlobalSCAPEmay need to expend significant resources to accomplish these goals.  If GlobalSCAPE fails to successfully developand market

 

12

----

 

new products or improve its direct and channel sales results, it maynot be able to achieve the necessary revenue growth and may not be profitable.

 

***GlobalSCAPE’s operations are vulnerable to securitybreaches that could harm the quality of its products and services or disruptits ability to deliver its products and services.***

*** ***

Third partiesmay breach GlobalSCAPE’s system security and damage its products and servicesor misappropriate confidential customer information.  This might cause GlobalSCAPE to losecustomers, or even cause customers to make claims on GlobalSCAPE for damages tothem. In addition, GlobalSCAPE may be required to expend significant resourcesto protect against security breaches and/or to address problems caused by suchbreaches.

 

***GlobalSCAPE’s products may expose customers toinvasion of privacy, causing customer dissatisfaction.***

*** ***

GlobalSCAPE’sSecure FTP Server is intended to provide outsiders access to a customer’scomputer, making the customer vulnerable to security breaches, which couldresult in the loss of their privacy or property.  If customers suffer invasions of privacy orother harm, this may result in customer dissatisfaction and possible claimsagainst us for any resulting damages.

 

***GlobalSCAPE’s products may contain defects that may becostly to correct, delay market acceptance of its products and damage itsreputation.***

*** ***

Errors may befound in GlobalSCAPE’s products after distribution.  If errors are discovered, GlobalSCAPE mayhave to make significant expenditures of capital to eliminate them and may notbe able to correct them in a timely manner or at all.  Errors and failures in GlobalSCAPE’s productscould result in a loss of, or delay in, market acceptance of its products andcould damage its reputation.

 

***GlobalSCAPE’s products rely on the prevalence ofWindows-based operating systems and if that technology fails to maintain orimprove market share, GlobalSCAPE’s products would not be as marketable.***

*** ***

Almost all ofGlobalSCAPE’s current software products can only be used on a Windows-basedoperating system and are not compatible with other operating systems.  Anything that affects Windows market sharenegatively could have a material adverse effect on the demand for GlobalSCAPE’sproducts.

 

***GlobalSCAPE’s internal controls are limited,increasing the risk of employee mismanagement or error.***

*** ***

All of ourfinance, accounting and SEC disclosure work is managed by a single officer,Thomas F. Farar, Chief Financial Officer, Secretary and Treasurer.  Mr. Farar has an accounting staff of twopersons. Without an increase in staffing, it may still be difficult for us toimplement the types of internal controls that are common to largercorporations, and we therefore face a greater risk of mismanagement or error inthese areas.

 

###### **Risks Related toStock Ownership**

###### ** **

***Our stock is a pennystock, which makes it more difficult to sell.***

 

A “penny stock”is any stock which is not traded on a national exchange or quoted on NASDAQ andwhich falls below a selling price of $5.00 per share in the public market. Ourcommon stock is quoted on the NASD’s OTC Bulletin Board and not on an exchangeor the NASDAQ, and it has traded from $0.10 to $1.05 since it began activetrading in February 2002.  The SEC’spenny stock rules require brokers and dealers to take certain steps beforetrading in a penny stock, making it more difficult to sell a penny stock thanother stock.  A sale of penny stock doesnot usually take place as quickly as a sale of other stock.  You may decide to sell your stock when themarket price is desirable to you, but by the time the sale is complete, theprice of the stock may have fallen to the point that the sale is no longerdesirable.  The price of penny stocks istypically more volatile than other stocks, exacerbating this problem.  Also, some brokers are unwilling to trade inshares of penny stocks.

 

13

----

 

***Our stock priceis/may be volatile.***

 

The tradingprice of our common stock has been and could continue to be subject to widefluctuations in response to certain factors, including:

 

**•**                  Quarter-to-quarter variations inresults of operations;

 

**•**                  Our announcements of new products;

 

**•**                  Our competitors’ announcements of newproducts;

 

**•**                  Our product development or releaseschedule;

 

**•**                  General conditions in the softwareindustry;

 

**•**                  Investor perceptions and expectationsregarding our products, plans and strategic position and those of our competitorsand customers.

 

In addition,the public stock markets experience extreme price and trading volumevolatility, particularly in high-technology sectors of the market.  This volatility has significantly affectedthe market prices of securities of many technology companies for reasons oftenunrelated to the operating performance of the specific companies.  The broad market fluctuations may adverselyaffect the market price of our common stock.

 

***We do not paydividends on our common stock.***

 

We have notpaid a dividend on our common stock and have no plan to do so in the nearfuture.

 

***Our principalshareholders may control our management decisions.***

 

Thomas Brown and David Mann, ownapproximately 70% of our outstanding common stock.  Therefore, Mr. Brown and Mr. Mann are able toexercise significant influence over all matters requiring shareholder approval,including the election of directors and approval of significant corporatetransactions.  This concentration ofownership may delay or prevent a change of control of GlobalSCAPE or discouragea potential acquirer from attempting to obtain control of GlobalSCAPE, eitherof which could have an adverse effect on the value of our common stock.

 

***Anti-takeoverprovisions in GlobalSCAPE’s charter and Delaware law could inhibit others fromacquiring GlobalSCAPE.***

 

Some of theprovisions of GlobalSCAPE’s certificate of incorporation and bylaws and inDelaware law could, together or separately:

 

**•**                  discourage potential acquisitionproposals;

 

**•**                  delay or prevent a change in control;and

 

**•**                  limit the price that investors may bewilling to pay in the future for shares of GlobalSCAPE’s common stock.

 

In particular,GlobalSCAPE’s certificate of incorporation and bylaws provide for, among otherthings, limitations on the individuals that may call meetings of thestockholders and do not allow for cumulative voting.  GlobalSCAPE is also subject to Section 203of the Delaware General Corporation Law, which generally prohibits a Delawarecorporation from engaging in any of a broad range of business combinations withany interested stockholder, as defined in the statute, for a period of threeyears following the date on which the stockholder became an interestedstockholder.

 

14

----

 

***Stockholders’ ownership of GlobalSCAPE stock may besignificantly diluted, affecting the value of the stock.***

*** ***

There areoptions for 1,970,071 shares currently outstanding under GlobalSCAPE’s employeestock option plans as of the date of this report.  Of the 1,970,071 options, 1,430,151 arevested.  We have filed a registrationstatement under the Securities Act of 1933, as amended (the “Securities Act”)covering stock issued upon the exercise of options by non-affiliates, and wemay file a registration statement covering options held by affiliates aswell.  If we do not file a registrationstatement covering affiliates, affiliates who exercise their options may chooseto sell the stock under an exemption from registration, such as Rule 144 underthe Securities Act.  The exercise ofthese options and sale of the resulting stock could depress the value of ourstock.

 

###### **Risks Related toLegal Uncertainty**

###### ** **

***GlobalSCAPE is vulnerable to claims that GlobalSCAPE’sproducts infringe third-party intellectual property rights particularly becauseGlobalSCAPE’s products are partially developed by independent parties.***

*** ***

GlobalSCAPEmay be exposed to future litigation based on claims that GlobalSCAPE’s productsinfringe the intellectual property rights of others. This risk is exacerbatedby the fact that some of the code in GlobalSCAPE’s products is developed byindependent parties or licensed from third parties over whom GlobalSCAPE hasless control than it exercises over internal developers.  In addition, we expect that infringement claimsagainst software developers will become more prevalent as the number ofproducts and developers grows and the functionality of software programs in themarket increasingly overlaps.  Claims ofinfringement could require GlobalSCAPE to re-engineer its products or seek toobtain licenses from third parties in order to continue offering itsproducts.  In addition, an adverse legaldecision affecting GlobalSCAPE’s intellectual property, or the use ofsignificant resources to defend against this type of claim could place asignificant strain on GlobalSCAPE’s financial resources and harm itsreputation.

 

***GlobalSCAPE may not be able to protect itsintellectual property rights.***

*** ***

GlobalSCAPE’ssoftware code, and trade and service marks are some of GlobalSCAPE’s mostvaluable assets.  Given the global natureof the Internet and GlobalSCAPE’s business, GlobalSCAPE is vulnerable to themisappropriation of this intellectual property, particularly in foreignmarkets, such as China and Eastern Europe, where laws or law enforcementpractices are less developed.  The globalnature of the Internet makes it difficult to control the ultimate destinationor security of GlobalSCAPE’s software making it more likely that unauthorizedthird parties will copy certain portions of GlobalSCAPE’s proprietaryinformation or reverse engineer the proprietary information used in itsprograms.  If GlobalSCAPE’s proprietaryrights were infringed by a third-party, and GlobalSCAPE did not have adequatelegal recourse, GlobalSCAPE’s ability to earn profits, which are highlydependent on those rights, would be severely diminished.

 

***Other companies may own, obtain or claim trademarksthat could prevent, limit or interfere with GlobalSCAPE’s use of itstrademarks.***

*** ***

GlobalSCAPE’svarious trademarks are important to its business.  If GlobalSCAPE were to lose the use of anyits trademarks, its business would be harmed and GlobalSCAPE would have todevote substantial resources towards developing an independent brandidentity.  Defending or enforcing GlobalSCAPE’strademark rights at a local and international level could result in theexpenditure of significant financial and managerial resources.

 

15

----

 

**Item 2.  Properties**

 

Our corporateoffice is located in a technical park in northwest San Antonio calledUniversity Park Tech Center II. Our lease for the 14,700 square foot facilityexpires in September 2008. Our annual rent is approximately $191,000. Webelieve these facilities will be suitable for our current business needs andthat suitable additional space will be available on acceptable terms whenneeded.

 

# **Item 3. Legal Proceedings**

#  

We are notcurrently involved in any material pending legal proceedings, but may becomesubject to legal proceedings in the ordinary course of our business.  Such claims may result in the expenditure ofsignificant financial and managerial resources.

 

##### **Item 4. Submission of Matters to a Vote of Security Holders**

##### ** **

None.

 

**Item 4A.**  **ExecutiveOfficers of the Company**

 

***Charles R. Poole*. **Mr.Poole has served as GlobalSCAPE’s President since February 2004.  From September 2003 until February 2004,he served as the company’s Vice President of Sales and Marketing.  Mr. Poole has over twenty years of experiencein senior management and sales with telecommunications companies, most recentlyas the President of GlobalSCAPE’s former parent company, ATSI Communications,Inc., from 1998 – 2001.  Mr. Poole hasserved as a Senior Vice President for A+ Communications, responsible forpaging, cellular and telemessaging sales from 1995 – 1997, as General Managerof American Paging, Texas from 1994 – 1995, as a Division Manager of DataDocuments, Inc. of Omaha, Nebraska from 1992 – 1994, as President of GeoComPartners, a satellite-based telecommunications company from 1989 – 1992, asSenior Vice President of MobileComm (a BellSouth Company) from 1984-1989, andas Regional Vice President of Burroughs Corp (now Unisys) from 1966-1984.

 

***Thomas F.Farar. ***Mr.Farar serves as GlobalSCAPE’s Treasurer, Secretary, and Chief FinancialOfficer.  He is responsible for allfinance and accounting functions. Mr. Farar joined GlobalSCAPE in June 2004.Prior to joining GlobalSCAPE, Mr. Farar served as Senior Accounting Manager(1999-2003) and Controller (2003-2004) for UDP, Ltd., a telecommunicationsservice bureau. Mr. Farar also served as Disbursements Supervisor for PG&EGas Transmission – Texas in 1999. Mr. Farar was Controller and Treasurer of CDHFeeders, Inc., an agricultural operation of cattle feedlots, and affiliatedcompanies from 1991-1998. Mr. Farar holds a B.B.A. in Accounting from TheUniversity of Texas at San Antonio.

 

16

----

 

# **Part II**

#  

##### **Item 5.  Marketfor Registrant’s Common Equity and Related Stockholder Matters and IssuerPurchases of Equity**

##### ** **

Our common stock is listed on the NASD’s OTCBulletin Board under the symbol GSCP. As of March 19, 2004, there were2,620 holders of record of our common stock representing approximately 9,000beneficial owners.  GlobalSCAPE stockbegan trading on February 15, 2002. The table below sets forth the quarterly high and low bid prices for ourcommon stock for the Company’s last two fiscal years.

 

**CommonStock Price**

 
| ** **                                | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
| **Fiscal Year ended December 31,**   | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| Annual                                    |       | $        | 0.36       |     | $          | 0.10 |   | $ | 0.27 |   | $ | 0.10 |   |
| First  Quarter (ending March 31)     |       | $        | 0.13       |     | $          | 0.10 |   | $ | 0.27 |   | $ | 0.16 |   |
| Second  Quarter (ending June 30)     |       | $        | 0.36       |     | $          | 0.11 |   | $ | 0.18 |   | $ | 0.10 |   |
| Third  Quarter (ending September 30) |       | $        | 0.23       |     | $          | 0.12 |   | $ | 0.18 |   | $ | 0.10 |   |
| Fourth  Quarter (ending December 31) |       | $        | 0.16       |     | $          | 0.13 |   | $ | 0.21 |   | $ | 0.13 |   |

 

The closingbid price on March 2, 2005 was $0.20. Over-the-counter market quotations reflect inter-dealer prices, withoutretail mark-up, mark-down, or commission and may not necessarily representactual transactions.

 

We have neverpaid a cash dividend, and do not expect to do so in the foreseeablefuture.  We expect to reinvest all of ourearnings in the further growth of the business.

 

Theinformation required to be disclosed in this Item regarding equity compensationplans is disclosed in Item 12 of this Annual Report.

 

17

----

 

##### **Item 6. Selected Financial Data**

##### ** **

The selectedfinancial data presented below for the years ended December 31, 2000,2001, 2002, 2003 and 2004 are derived from our audited financial statements.

 
| ** **                                                                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                            | ** ** | **2000**                          | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:                                                                             |       |                              |       |   |   |   |   |   |   |   |   |
| Software  product revenues                                                            |       | $                                 | 5,165,668  |   | $ | 5,259,148 |   | $ | 5,269,503 |   | $ | 4,847,119 |   | $ | 4,930,660 |   |
| Advertising  revenues                                                                 |       | 570,008                           |       | 38,540 |   | — |   | — |   | — |   |
| Total  revenues                                                                       |       | 5,735,676                         |       | 5,297,688 |   | 5,269,503 |   | 4,847,119 |   | 4,930,660 |   |
| Operating  expenses:                                                                  |       |                              |       |   |   |   |   |   |   |   |   |
| Cost of  revenues (exclusive of depreciation and amortization shown separately below) |       | 200,118                           |       | 323,309 |   | 353,918 |   | 532,910 |   | 371,242 |   |
| Selling,  general and administrative                                                  |       | 3,463,044                         |       | 3,551,498 |   | 3,580,361 |   | 3,613,759 |   | 3,456,598 |   |
| Research and  development                                                             |       | 961,002                           |       | 1,176,714 |   | 848,212 |   | 945,395 |   | 727,423 |   |
| Depreciation  and amortization                                                        |       | 430,221                           |       | 546,017 |   | 544,063 |   | 390,154 |   | 171,834 |   |
| Settlement  with ATSI Comm. Inc.                                                      |       | —                            |       | — |   | 392,905 |   | — |   | — |   |
| Total  operating expenses                                                             |       | 5,054,385                         |       | 5,597,538 |   | 5,719,459 |   | 5,482,218 |   | 4,727,097 |   |
| Income  (loss) from operations                                                        |       | 681,291                           |       | (299,850 | ) | (449,956 | ) | (635,099 | ) | 203,563 |   |
| Interest  expense, net                                                                |       | (42,839                           | )          | 4,420 |   | 11,783 |   | (5,016 | ) | (1,651 | ) |
| Gain (loss)  on sale of assets                                                        |       | (13,687                           | )          | — |   | — |   | (1,486 | ) | — |   |
| Income  (loss) before provision for income taxes                                      |       | 624,765                           |       | (295,430 | ) | (438,173 | ) | (641,601 | ) | 201,912 |   |
| Total income  tax provision (benefit)                                                 |       | 310,126                           |       | (38,295 | ) | 175,202 |   | 1,400 |   | 1,498 |   |
| Net income  (loss)                                                                    |       | $                                 | 314,639    |   | $ | (257,135 | ) | $ | (613,375 | ) | $ | (643,001 | ) | 200,423 |   |
| Net income  (loss) per common share - basic                                           |       | $                                 | 0.02       |   | $ | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) | $ | 0.01 |   |
| Net income  (loss) per common share -assuming dilution                                |       | $                                 | 0.02       |   | $ | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) | $ | 0.01 |   |

 
| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2000**              | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|                                                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Cash                                                                      |       | $                     | 113,591    |   | $ | 134,537 |   | $ | 480,609 |   | $ | 342,433 |   | $ | 572,959 |   |
| Working  capital (deficit)                                                |       | 161,939               |       | 498,134 |   | 368,567 |   | 19,203 |   | 341,749 |   |
| Total assets                                                              |       | 2,122,094             |       | 2,009,806 |   | 1,412,042 |   | 918,278 |   | 971,857 |   |
| Long term  debt including capital lease obligations, less current portion |       | 149,074               |       | 77,080 |   | 15,477 |   | — |   | — |   |
| Cash  dividends per common share                                          |       | $                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                           |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

----

 

##### **Item 7.  Managem**ent’s Discussionand Analysis of Financial Condition and Results of Operation

 

**Overview**

 

GlobalSCAPEdevelops and distributes Internet related software including file management,content management and Web development tools. We distribute our software primarily via download from our Internetwebsite.  During 2004, approximately 64%of our revenues were generated from customers within the United States, withthe remaining 36% concentrated mostly in Western Europe, Canada and Australia.CuteFTP and CuteFTP Pro accounted for approximately 75% and 69% of totalrevenues in 2003 and 2004 respectively. Combined sales of these two products declined approximately 7% from 2003to 2004.  This decline was primarily insales of CuteFTP, which declined approximately 36%.  Sales of CuteFTP Pro increased byapproximately 41% year over year and sales of Secure Server, a companionproduct to CuteFTP Pro, increased 107%. Secure Server accounted for approximately 14% of total revenues in 2004,increasing from 7% of total revenues in 2003.

 

Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. While it cannot be determined with certainty, CuteFTP and CuteFTP Promay have reached such a point their lifecycles. Management believes that the market for stand-alone FTP clients for homeconsumers may be declining.  However, wehave not seen the same decline in the market for secure FTP clients and serverssuch as CuteFTP Pro and Secure Server which we believe better target the needsof businesses.

 

Our strategyis to continue enhancing our file transfer products across the board to meetthe demands of both individual and enterprise users, while improving thesecurity features of our current product line. We dedicated considerable resources in the fourth quarter of 2002 and in2003 to the development and market launch of PureCMS, our content managementproduct.  To date, we have not been assuccessful in selling this product as we had anticipated.  We laid off 9 of 45 employees on February 12,2004 in order to bring our expenses in line with our current operatingperformance.

 

 We are encouraged with the interest we see inour new enhanced file transfer offerings so far in 2005. We will continue toaddress security issues for our customers. We intend to release new versions ofCuteFTP, CuteFTP Pro and Secure Server early in 2005 and we believe we can slowthe decline in sales of CuteFTP and improve sales of CuteFTP Pro and SecureServer.  We plan on releasing additionalversions of EFT throughout 2005.

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations should be read in conjunction with our financial statements for theyears ended December 31, 2002, 2003 and 2004 and related notes includedelsewhere in this document.

 

##### **Liquidity and Capital Resources**

 

We relyheavily on cash flows from operations and these cash flows are directly linkedto CuteFTP and CuteFTP Pro, which accounted for 75% and 69% of our revenues in2003 and 2004, respectively.  Anythingthat has a negative impact on these products will negatively impact our cashflow from operations and our ability to meet our commitments.  Demand for our products could be affected bymany factors including rapid technological obsolescence.  For more discussion on the risks that mightaffect demand for our products, you should read the information under “RiskFactors” in this Annual Report.

 

We incurredsignificant operating losses during the years ended December 31, 2002 and2003 and continued, in January, February and March of 2004, to incursignificant operating losses.  In February 2004we reduced our workforce by 20%, laying off 9 of the 45 people then employed bythe Company.  This workforce reductionwas a necessary step in improving the overall financial health of theorganization.  We had anticipatedstronger revenue performance in January and February after poorerthan expected sales in 

 

19

----

 

the fourth quarter of 2003 and had maintained staffing levels with thisobjective.  These higher revenue targetswere not met, further reducing the Company’s liquidity position.

 

The Company’sliquidity could be further reduced in 2005 if sales of CuteFTP continue todecline and the Company is unable to successfully introduce new products orincrease sales of existing products.

 

If salescontinue to decline or the Company’s liquidity otherwise requires, managementhas the intent and ability to substantially reduce personnel andpersonnel-related costs, reduce or substantially eliminate capital expendituresand/or reduce or substantially eliminate research and development expenditures.

 

In addition,the Company could draw on its $250,000 line of credit, if necessary.  This line of credit, which matured in December 2004,has been renewed through March 2006. The interest rate is subject to change and is indexed to the bank’sprime rate.  The initial rate is7.25%.  In connection with the line ofcredit, GlobalSCAPE entered into a commercial security agreement with the bankwhereby GlobalSCAPE granted a security interest in all its accounts andequipment.  The Company borrowed $100,000on September 11, 2003 under this agreement.  This amount was repaid in February 2004.  The credit facility is available to theCompany at any point during its term.

 

The Company’sflexibility in reacting to changes in the operating environment and to changingeconomic conditions may be limited by the Company’s current liquidity position.  However, management believes that, ifrequired, it will be able to effect some or all of the components of the planset forth above, which are sufficient in the aggregate to enable the Company tocontinue as a going concern through at least December 31, 2005.  Accordingly, the financial statements of theCompany do not include any adjustments to reflect the possible future effectsor the recoverability and classification of assets or the amounts andclassification of liabilities that may result if the Company cannot improve itsworking capital position additionally.

 

Net cashprovided (used) by operating activities was $483,077, ($105,548) and $384,314in 2002, 2003 and 2004, respectively. Net cash provided by operating activities in 2002 was primarily due toadjustments related to depreciation and amortization and the settlement withATSI, offset by the loss for the period. Net cash used in operating activities in 2003 was primarily the resultof the net loss for the period offset somewhat by depreciation and amortizationcharges for the period. In 2004, net cash provided resulted from net income,adjustments related to depreciation and amortization as well as decreasedaccounts receivable.

 

Net cash usedin investing activities for 2002, 2003 and 2004 was $87,822, $73,027, and$42,250 respectively.  In 2002, we loaned$200,000 to ATSI, our parent company, but received $200,000 in cash as part ofthe settlement agreement.  In addition,we purchased $87,822 in computer hardware and software in 2002.  In 2003, we capitalized the purchase of$73,027 in equipment and software. In 2004, we capitalized the purchase of$42,250 in equipment and software.

 

Net cashprovided (used) in financing activities during 2002, 2003 and 2004 was ($49,183), $40,399 and ($111,538), respectively. In 2002, we made principal payments of $71,321 on capital leaseobligations and received $22,138 for the exercise of stock options.  In 2003, we made principal payments of$61,317 on capital lease obligations and borrowed $100,000 under our line ofcredit and received $1,716 for the exercise of stock options.  In 2004, we made principal payments on notespayable of $100,000 and made principal payments of $15,294 on capital leaseobligations and received $3,756 for the exercise of stock options. We did notenter any new capital leases in 2004.

 

As of December 31,2004, we had $572,959 in cash, current assets of $812,637 and currentliabilities of $470,888, resulting in working capital of $341,749.  This resulted in a working capitalimprovement of $322,546 over December 31, 2003. Our principal commitmentsconsisted of obligations outstanding under operating leases as well as royaltyagreements with third parties.  Thecommitments related to royalty agreements are not fixed, rather they arecontingent on sales.  We plan to continueto expend significant resources on product development in future periods andmay also use our cash to acquire 

 

20

----

 

or license technology, products or businesses related to our currentbusiness.  We expect that operatingexpenses will continue to be a material use of our cash resources as well, butwill manage the business based on the immediately foreseeable operating cashflows.  The facility that we currentlyoccupy is expected to be sufficient for the next twelve months.  Consequently, we do not anticipatesignificant expenditures for leasehold improvements or furniture for 2005.

 

The followingtable summarizes our contractual obligations at December 31, 2004,consisting of future minimum capital lease payments and future minimum paymentsunder operating leases:

 
| ** **                   | ** ** | **Payments due by period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual obligations**  | ** ** | **Total**                  | ** ** | **Less than   1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than  5 years** | ** ** |
| Operating  lease obligations |       | $                          | 667,306    |   | $ | 190,659 |   | $ | 381,318 |   | $ | 95,329 |   | $ | — |   |
| Total                        |       | $                          | 667,306    |   | $ | 190,659 |   | $ | 381,318 |   | $ | 95,329 |   | $ | — |   |

 

##### **Critical Accounting Policies**

 

# ***Use of Estimates***

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations are basedupon the Company’s financial statements, which have been prepared in accordancewith accounting principles generally accepted in the Unites States.  The preparation of these financial statementsrequires management to make estimates and assumptions that affect the reportedamount of assets and liabilities.  On anongoing basis, management evaluates its estimates and judgments, includingthose related to revenue recognition, allowance for doubtful accounts receivable,long-lived and intangible assets, income taxes and contingencies.  Management bases its estimates on historicalexperience, observable trends, and various other assumptions that are believedto be reasonable under the circumstances. Management uses this information to make judgments about the carryingvalues of assets and liabilities that are not readily apparent form othersources.  Actual results may differ fromthe estimates under different assumptions or conditions.

 

Managementbelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its financial statements.

 

***RevenueRecognition***

* *

Our revenue is generatedprimarily by licensing our software products and providing support for thoseproducts.  Revenues are comprisedof the gross selling price of the software, including shipping charges and theearned portion of support and maintenance agreements.  In periods where we had revenue fromadvertising, we recognized the net proceeds received from advertisers asrevenue.  The Company recognizes revenuein accordance with the American Institute of Certified Public AccountantsStatement of Position (“SOP”) 97-2, *SoftwareRevenue Recognition*, as modified by SOP 98-9, *Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions*.

 

Revenues fromthe sale of software products are recognized and completely earned uponshipment or electronic delivery of the product provided that persuasiveevidence of an arrangement exists, collection is probable, payment terms arefixed and determinable and no significant obligations remain.  The majority of our sales are deliveredelectronically via email.

 

We also selltechnical support and maintenance agreements (post contract customer support “PCS”),which are sometimes bundled with the software. When vendor specific objective evidence 

 

21

----

 

(“VSOE”)of fair value exists for all elements in a multiple element arrangement,revenue is allocated to each element based on the relative fair value of eachof the elements. VSOE of fair value is established by the price charged whenthe same element is sold separately.  Ina multiple element arrangement whereby VSOE of fair value of all undeliveredelements exists but VSOE of fair value does not exist for one or more deliveredelements, revenue is recognized using the residual method. Under the residualmethod, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is recognized as revenue, assumingcollection is probable.  Revenueallocated to PCS is recognized ratably over the contractual term, typically oneyear.  We sometimes sell installation andtraining services with our PureCMS and EFT products.  Revenue for installation and training isrecognized when performed.

 

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001.  Deferredrevenue grew to a balance of approximately $142,000 at December 31, 2002and remained relatively flat, ending 2003 with a balance of approximately$140,000.  Sales of these agreementscontinued to grow in 2004 with higher priced support and maintenance for ourenterprise class software products and our efforts to renew agreements upontheir expiration.  Growth in the sales ofmaintenance and support agreements may result in the deferred recognition of asignificant amount of revenue in future periods.

 

***Allowance for Doubtful Accounts***

 

We providecredit, in the normal course of business, to a number of companies and performongoing evaluations of our credit risk. We require no collateral from our customers and we estimate theallowance for uncollectible accounts based on our historical experience andcurrent credit evaluations.  No singlecustomer accounted for more than 2% of net revenues in 2002, 2003 or 2004.

 

***Valuationof Long-Lived and Intangible Assets***

 

The Companyassesses the impairment of long-lived and intangible assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable.  Factors consideredimportant which could trigger an impairment review included the following:  significant underperformance relative tohistorical or projected future cash flows; significant changes in the manner ofuse of the assets or the strategy for the overall business; and significantnegative industry trends.  Whenmanagement determines that the carrying value of long-lived and intangibleassets may not be recoverable, impairment is measured based on the excess ofthe assets’ carrying value over the estimated fair value.  No impairment was recognized in 2002, 2003 or2004.

 

***Stock-BasedCompensation***

 

The Companymeasures compensation expense for its stock-based employee compensation plans,which are described in Note 8.  Statementof Financial Accounting Standards 123, *Accountingfor Stock-Based Compensation* (SFAS 123), encourages, but does not require, companies to recordcompensation cost for stock-based employee compensation plans based on the fairmarket value of options granted. The Company chose to account for stock basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price.  On December 31,2002, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standard 148, *Accountingfor Stock Based Compensation - Transition and Disclosure* (SFAS 148),which amends SFAS 123.  SFAS 148 requiresmore prominent and frequent disclosures about the effects of stock-basedcompensation. The Company will continue to account for its stock-basedcompensation according to the provisions of APB Opinion No. 25.  The pro forma disclosure requirementsprescribed by SFAS 123, as amended by SFAS 148 are included in Note 1 to theFinancial Statements.

 

***See note 1 to the financial statements on page 43 underthe heading Stock Options.  The Companywill adopt the fair value method of accounting for stock options during thethird quarter of 2005.***

 

22

----

 

***Research and Development***

 

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological feasibility is achieved.For the years 2002, 2003 and 2004, we spent approximately $848,000, $945,000and $728,000 respectively, on research and development.  No research and development expenses werecapitalized in 2002, 2003 or 2004 and all previously capitalized research anddevelopment expenses were fully amortized at December 31, 2002.

 

# ***Income Taxes***

 

GlobalSCAPEaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liabilitymethod provides that the deferred tax assets and liabilities are recorded basedon the difference between the tax bases of assets and liabilities and theircarrying amount for financial reporting purposes, as measured by the enactedtax rates and laws that will be in effect when the differences are expected toreverse.  Deferred tax assets are carriedon the balance sheet with the presumption that they will be realizable infuture periods when pre-tax income is generated.  Predicting the ability to realize theseassets in future periods requires a great deal of judgment by management.   Although we have generated pre-tax income inprevious years, unusual or infrequently occurring transactions resulted in pre-taxlosses in 2001 and 2002 (compensation charges in 2001 and the settlement withATSI and termination of CEO in 2002).  Itis our judgment that we cannot predict with reasonable certainty that the taxassets resulting from these losses and the loss incurred in 2003 will be fullyrealized in future periods.  Statementof Financial Accounting Standards (SFAS) No. 109 requires a valuationallowance to reduce the deferred tax assets reported if, based on the weight ofthe evidence, it is more likely than not that some portion or all of thedeferred tax assets will not be realized. After consideration of all of theevidence, both positive and negative, management determined that a $540,350valuation allowance at December 31, 2003 and $484,853 valuation allowanceat December 31, 2004, was necessary to reduce the deferred tax assets tothe amount that will more likely than not be realized.  The change in thevaluation allowance for the current year is a net decrease of $55,497.  AtDecember 31, 2004, GlobalSCAPE has available net operating loss carryforwardsof approximately $1,249,000, which expire beginning in the year 2020.

 

##### **Comparison of Year Ended December 31, 2004 toYear Ended December 31, 2003**

 

***Revenue.***  We derive our revenues primarily fromsoftware sales.  Revenue is comprised ofthe gross selling price of software, including shipping charges and the earnedportion of support and maintenance agreements. Revenues increased approximately 2% from 2003 to 2004, from $4,847,119in 2003 to $4,930,660 in 2004.  Unitvolume was relatively flat with approximately 175,000 sold in 2003 versus170,000 in 2004.  The increase inrevenues was pronounced in the fourth quarter when compared to the same periodsin 2003.  We believe the economicuncertainty in the first three quarters of 2004 contributed to those periods’poor performance along with the turnover in our sales force. Our fourth quarterrevenues increased approximately 11% over the same quarter in 2003.

 

In 2003 and2004, approximately 75% and 69%, respectively, of our revenues were generatedfrom sales of CuteFTP and CuteFTP Pro. Combined sales of these products declined approximately 7% year overyear.  Sales of CuteFTP declinedapproximately 36% while sales of CuteFTP Pro increased approximately 41%.  Our reliance on these products may negativelyimpact future results from operations if we are unable to maintain revenuesfrom these products or successfully introduce new product offerings.  (For more information, you should read the section titled*Risks Related to Operations.*)

 

***Cost of Revenues.***  Cost of revenues consists primarily ofroyalties, a portion of our bandwidth costs as well as production, packagingand shipping costs for boxed copies of software products. Cost of revenuesdecreased approximately 30% between periods from $532,910 in 2003 to $371,242in 2004 due to a decrease in royalty expenses related to our softwaredistribution agreements with third parties. Royalties that the Company pays on software products licensed from thirdparties, which it resells, are expensed as a 

 

23

----

 

cost of sales when the software product is sold or earlier if therecoverability of any prepaid royalties is in doubt.  The Company has distribution agreements withHannon Hill Corp., Trellix Corp., Perseus Development Corp., Beehive Software, Inc.,Visicom Media, Inc., and Turillion Software Technologies.  The GlobalSCAPE software products associatedwith each of the companies are PureCMS, CuteSITE Builder, Web Survey, Mac FTP,CuteHTML Pro and Protect IIS, respectively. GlobalSCAPE no longer distributes the Protect IIS product and expensedprepaid royalties of approximately $15,000 in December 2003.  GlobalSCAPE’s agreement with Hannon HillCorp. required a minimum royalty of $16,667 per month, as prepayment of royalties,for 12 months beginning in December 2002. These payments were expensed as paid because the lower than expectedsales of PureCMS raised doubt as to the realization of benefit from theseprepayments.  The total amount expensedin 2003 relating to these prepayments was $183,337.  As a result of, we expect the cost ofrevenues to remain consistent both as a percentage of sales and in gross termsin 2005 when compared to 2004.

 

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, professional fees,rent, bad debt and credit card transaction fees. Selling, general andadministrative expenses decreased approximately 4%  a year from $3,613,759 in 2003 to $3,456,598in 2004. The number of persons employed by GlobalSCAPE was reduced from 45 to36 in February 2004. As of March 3, 2005 the number of employees was39.

 

Forcomparative purposes, selling, general and administrative expenses for 2003includes approximately $540,000 in advertising expenses, relating primarily tothe launch of the PureCMS product, as compared to $205,000 in 2004. Selling,general and administrative expenses also include approximately $134,900 inamortization of the CuteFTP trademark in 2003, when it was fully amortized.

 

***Research andDevelopment.*** Research and development expenses decreased approximately 23% from$945,395 in 2003 to $727,423 due to layoff of employees in February 2004and related salaries, payroll taxes and benefits costs. External developmentcosts increased approximately 11% from 2003 to 2004. External development wasincreased to offset the loss of internal labor due to the layoff in order tomaintain the scheduled releases of CuteFTP, CuteFTP Pro, Secure FTP Server,PureCMS and EFT.

 

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets and the amortization of the trademark associatedwith our purchase of CuteFTP in 1998. Depreciation and amortization expense declined $218,320 or approximately56% year over year.  This decrease wasdue primarily to a reduction in amortization expense.  The purchase of CuteFTP was fully amortizedas of September 20, 2003.  Inaddition, depreciation expense has declined due to a slowdown in additions tofixed assets in current periods relative to prior periods.

 

***Interest Expense,Net.***  In2003, we had interest expense of $5,016 related primarily to capitalleases.  In 2004, we had interest expenseof $1,651 related primarily to an advance on our line of credit and financingof insurance premiums.

 

***Income Taxes.***  The provision for state income taxes in 2003was $1,400 and there was no provision for federal income taxes in 2003.  GlobalSCAPE’s effective income tax rate wasnegative 0.2% and differs from the federal rate primarily because of a changein the valuation allowance for deferred tax assets.  The provision for state income taxes in 2004was $1,489 and there was no provison for federal income taxes in 2004.GlobalSCAPE’s effective income tax rate is 0.7% and differs from the federalrate primarily because of a change in the valuation allowance for deferred taxassets.

 

***Net Income.***  In 2003, the net loss was primarily theresult of disappointing revenue performance in the first and fourth quartersexacerbated by the product launch expenses related to PureCMS. In 2004, the netincome was primarily the result of a slight increase in revenue, a decrease inthe cost of revenues, SG&A, research and development and depreciationcosts. Significant effort was put in to controlling expenses in 2004, includingthe layoff of 9 employees.

 

24

----

 

##### **Comparison of Year Ended December 31, 2003 toYear Ended December 31, 2002**

 

***Revenue.***  We derive our revenues primarily fromsoftware sales.  Revenue is comprised ofthe gross selling price of software, including shipping charges and the earnedportion of support and maintenance agreements. Revenues declined approximately 8% from 2002 to 2003, from $5,269,503 in2002 to $4,847,119 in 2003.  Unit volumewas relatively flat with approximately 172,000 sold in 2002 versus 175,000 in2003.  The decline in revenues waspronounced in the first and fourth quarters when compared to the same periodsin 2002.  We believe the economicuncertainty in the first quarter of 2003 contributed to that period’s poorperformance and the turnover in our sales force contributed to the weaker thanexpected performance in the fourth quarter of 2003.

 

In 2002 and2003, approximately 85% and 75%, respectively, of our revenues were generatedfrom sales of CuteFTP and CuteFTP Pro. Combined sales of these products declined approximately 21% year overyear.  Sales of CuteFTP declinedapproximately 29% while sales of CuteFTP Pro declined approximately 2%.  Our reliance on these products may negativelyimpact future results from operations if we are unable to maintain revenuesfrom these products or successfully introduce new product offerings.  (For more information, you should read the section titled*Risks Related to Operations.*)

 

***Cost of Revenues.***  Cost of revenues consists primarily ofroyalties, a portion of our bandwidth costs as well as production, packagingand shipping costs for boxed copies of software products. Cost of revenuesincreased approximately 51% between periods from $353,918 in 2002 to $532,910in 2003 due to an increase in royalty expenses related to our softwaredistribution agreements with third parties. Royalties that the Company pays on software products licensed from thirdparties, which it resells, are expensed as a cost of sales when the softwareproduct is sold or earlier if the recoverability of any prepaid royalties is indoubt.  The Company has distributionagreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp.,Beehive Software, Inc., Visicom Media, Inc., and Turillion SoftwareTechnologies.  The GlobalSCAPE softwareproducts associated with each of the companies are PureCMS, CuteSITE Builder,Web Survey, Mac FTP, CuteHTML Pro and Protect IIS, respectively.  GlobalSCAPE no longer distributes the ProtectIIS product and expensed prepaid royalties of approximately $15,000 in December 2003.  GlobalSCAPE’s agreement with Hannon HillCorp. required a minimum royalty of $16,667 per month, as prepayment ofroyalties, for 12 months beginning in December 2002.  These payments were expensed as paid becausethe lower than expected sales of PureCMS raised doubt as to the realization ofbenefit from these prepayments.  The totalamount expensed in 2003 relating to these prepayments was $183,337.

 

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, professional fees,rent, bad debt and credit card transaction fees. Selling, general andadministrative expenses grew approximately one percent year over year from$3,580,361 in 2002 to $3,613,759 in 2003. The number of persons employed byGlobalSCAPE grew from 39 at the end of 2002 to 45 by December 2003.

 

Forcomparative purposes, selling, general and administrative expenses for 2002includes reductions to SG&A expense of $62,396 for non-cash charges relatedto stock options and $190,000 in severance payments to our former CEO, TimNicolaou, which were not incurred in 2003. Selling, general and administrativeexpenses also include approximately $300,000 in advertising expenses in 2002,which increased to $540,000 in 2003, both of which relate primarily to thelaunch of the PureCMS product.

 

***Research andDevelopment.*** Research and development expenses increased approximately 11% from$848,212 in 2002 to $945,395 due to increased expenditures on both internal andexternal product development resources. We increased spending substantially in the fourth quarter of 2003 onexternal development resources as part of the planned 2004 releases of newversions of CuteFTP, CuteFTP Pro and Secure FTP Server.

 

25

----

 

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets and the amortization of the trademark associatedwith our purchase of CuteFTP in 1998. Depreciation and amortization expense declined $153,909 or approximately28% year over year.  This decrease wasdue primarily to a reduction in amortization expense.  Previously capitalized software developmentcosts were fully amortized at December 31, 2002 and the purchase ofCuteFTP was fully amortized as of September 20, 2003.  In addition, depreciation expense hasdeclined due to a slowdown in additions to fixed assets in current periodsrelative to prior periods.

 

***Settlement of Duefrom Parent Balance. ***OnJune 11, 2002, ATSI Communications, Inc. sold its majority interestin GlobalSCAPE, Inc. to Brown and Mann-GlobalSCAPE Joint Venture, a Texasgeneral partnership owned by San Antonio-based investors Thomas W. Brown andDavid L. Mann.  Contemporaneously withthis transaction, GlobalSCAPE agreed to compromise and settle a $612,304inter-company balance owed to it by ATSI, which resulted in charges toGlobalSCAPE of  $392,905.  The balance was settled for (i) $200,000in cash from ATSI; (ii) NTFC Capital Corporation’s release of GlobalSCAPEas a co-borrower on a capital lease executed by ATSI in 1999, and (iii) ATSI’sagreement to provide $50,000 worth of transition support services toGlobalSCAPE over the nine months ending March 11, 2003, including payrolladministration and GlobalSCAPE’s continued use of a shared accountingplatform.  However, we completed ourtransition from ATSI’s payroll and accounting systems during the third quarterof 2002 and expensed the remainder of the support services as selling, generaland administrative expenses, approximately $46,000, during that quarter.  In addition, prepaid insurance coverage undera joint policy with ATSI was lost to GlobalSCAPE as a result of the change incontrol, resulting in a charge against GlobalSCAPE’s prepaid assets of $27,083during the second quarter of 2002.

 

***Interest Expense,Net.***  In2002, we had interest expense of $8,973 related to capital leases and interestincome of $20,756 from loans made to ATSI prior to our separation andsettlement of the balance owed to GlobalSCAPE by ATSI.  In 2003, we had interest expense of $5,016related primarily to capital leases.  Wedo not expect to generate interest income in future periods.

 

***Income Taxes.***  The provision for federal income taxes was$146,932 for 2002.  The provision forstate income taxes was $28,270 for the same period.  GlobalSCAPE’s effective income tax rate wasnegative 40% in 2002 and differs from the federal rate primarily because of achange in the valuation allowance for deferred tax assets.  The provision for state income taxes in 2003was $1,400 and there was no provision for federal income taxes in 2003.  GlobalSCAPE’s effective income tax rate wasnegative 0.2% and differs from the federal rate primarily because of a changein the valuation allowance for deferred tax assets.

 

***Net Income.***  In 2002, the net loss was a result of boththe settlement with ATSI and the termination of our former CEO.  These two events combined for more than$580,000 in expenses whereas our loss from operations was about $450,000.  In 2003, the net loss was primarily theresult of disappointing revenue performance in the first and fourth quartersexacerbated by the product launch expenses related to PureCMS.

 

##### **Inflation**

 

Increases ininflation generally result in higher interest rates and operating costs.  Our largest cost exposure is the cost ofsalaries and general and administrative expenses. To date we believe thatinflation has not had a significant impact on our operations.

 

26

----

 

##### **Item 7A.  Quantita**tive andQualitative Disclosures About Market Risk

 

To date, wehave not utilized derivative financial instruments or derivative commodityinstruments.  We do not expect to employthese or other strategies to hedge market risk in the foreseeable future.  We may invest our cash in money market funds,which are subject to minimal credit and market risk.  We believe that the interest rate risk andother relevant market risks associated with these financial instruments areimmaterial.

 

In 2004approximately 36% of our revenues came from customers outside the UnitedStates. All revenues are received in U.S. dollars so we have no exchange raterisk with regard to the sale.  However,as of July 1, 2003, the European Union (EU) enacted Value Added Taxes(VAT) on electronic purchases.  Thesetaxes are charged to our non-business customers in the EU and, in our case, areremitted quarterly in pound sterling.  We expect that the impact of any currency translation involved in theremittance of VAT taxes will not be material to our business.

 

27

----

 

**Item8.  Financial****Statements and Supplementary Data**

 

**GlobalSCAPE, Inc.**

**Index to Consolidated Financial Statements**

**Years ending December 31, 2002, 2003 and 2004**

 

**Contents**

** **
| Report of Independent Registered Public  Accounting Firm - Helin, Donovan, Trubee & Wilkinson, LLP |   |
|-------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public Accounting Firm - Ernst &  Young, LLP                      |   |
| Financial Statements                                                                                        |   |
| Consolidated Balance Sheets                                                                                 |   |
| Consolidated Statements of Operations                                                                       |   |
| Consolidated Statements of Stockholders’  Equity                                                       |   |
| Consolidated Statements of Cash Flows                                                                       |   |
| Notes to Consolidated Financial Statements                                                                  |   |

 

28

----

 

**Reportof Indep****endentRegistered Public Accounting Firm**

 

 

TheBoard of Directors and Shareholders

GlobalSCAPE, Inc.:

 

We have audited the accompanying consolidated balance sheet of GlobalSCAPE, Inc. (the Company) as of December 31, 2004, and the related statements of operations, stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position of GlobalSCAPE, Inc. as of December 31, 2004, and theresults of their operations and their cash flows for the year then ended inconformity with generally accepted accounting principles in the United Statesof America.

 

 

**Helin,Donovan, Trubee & Wilkinson, LLP**

 

 

February 25,2005

Austin,Texas

 

 

29

----

 

**Report of IndependentRegistered Public AccountingFirm**

 

 

To the Board of Directors

GlobalSCAPE, Inc.

 

We haveaudited the accompanying consolidated balance sheet of GlobalSCAPE, Inc.as of December 31, 2003 and the related statements of operations,stockholders’ equity and cash flows for the years ended December 31, 2003and 2002. These financial statements are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conductedour audits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of GlobalSCAPE, Inc. as of December 31,2003 and the results of its operations and its cash flows for the years ended December 31,2003 and 2002 in conformity with accounting principles generally accepted inthe United States.

 

 

Ernst & Young LLP

 

San Antonio, Texas

February 27, 2004,except for Notes 5 and 10, as to which the date is March 30, 2004.

 

30

----

 

**GlobalSCAPE, Inc.**

**Consolidated Balance Sheets**

** **
| ** **                                                                                                           | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Assets                                                                                                               |       |                  |       |   |   |
| Current  assets:                                                                                                     |       |                  |       |   |   |
| Cash                                                                                                                 |       | $                     | 342,433    |   | $ | 572,959 |   |
| Accounts  receivable (net of allowance for doubtful accounts of $43,581 and $10,195 in  2003 and 2004, respectively) |       | 240,615               |       | 148,534 |   |
| Prepaid  expenses                                                                                                    |       | 46,428                |       | 91,144 |   |
| Total current  assets                                                                                                |       | 629,476               |       | 812,637 |   |
|                                                                                                                 |       |                  |       |   |   |
| Property and  equipment:                                                                                             |       |                  |       |   |   |
| Furniture  and fixtures                                                                                              |       | 332,920               |       | 332,920 |   |
| Software                                                                                                             |       | 235,436               |       | 245,601 |   |
| Equipment                                                                                                            |       | 590,019               |       | 608,718 |   |
| Leasehold  improvements                                                                                              |       | 154,376               |       | 167,762 |   |
|                                                                                                                 |       | 1,312,751             |       | 1,355,001 |   |
| Accumulated  depreciation and amortization                                                                           |       | 1,035,830             |       | 1,207,663 |   |
| Net property  and equipment                                                                                          |       | 276,921               |       | 147,338 |   |
|                                                                                                                 |       |                  |       |   |   |
| Other  assets:                                                                                                       |       |                  |       |   |   |
| Other                                                                                                                |       | 11,881                |       | 11,882 |   |
| Total other  assets                                                                                                  |       | 11,881                |       | 11,882 |   |
|                                                                                                                 |       |                  |       |   |   |
| Total assets                                                                                                         |       | $                     | 918,278    |   | $ | 971,857 |   |

 

31

----

 

**GlobalSCAPE, Inc.**

**Consolidated Balance Sheets**

** **
| ** **                                                                                                                                                                          | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Liabilities  and Stockholders’ Equity                                                                                                                                          |       |                  |       |   |   |
| Current  liabilities:                                                                                                                                                               |       |                  |       |   |   |
| Accounts  payable                                                                                                                                                                   |       | $                     | 180,555    |   | $ | 122,117 |   |
| Accrued  expenses                                                                                                                                                                   |       | 173,935               |       | 170,654 |   |
| Deferred  revenue                                                                                                                                                                   |       | 140,489               |       | 178,117 |   |
| Notes  payable                                                                                                                                                                      |       | 100,000               |       | — |   |
| Current  portion of capital lease obligation                                                                                                                                        |       | 15,294                |       | — |   |
| Total  current liabilities                                                                                                                                                          |       | 610,273               |       | 470,888 |   |
|                                                                                                                                                                                |       |                  |       |   |   |
| Long-term  liabilities:                                                                                                                                                             |       |                  |       |   |   |
| Other long-term  liabilities                                                                                                                                                        |       | 39,253                |       | 28,038 |   |
| Total  long-term liabilities                                                                                                                                                        |       | 39,253                |       | 28,038 |   |
|                                                                                                                                                                                |       |                  |       |   |   |
| Total  Liabilities                                                                                                                                                                  |       | 649,526               |       | 498,926 |   |
|                                                                                                                                                                                |       |                  |       |   |   |
| Commitments  and contingencies                                                                                                                                                      |       |                  |       |   |   |
|                                                                                                                                                                                |       |                  |       |   |   |
| Stockholders’  equity:                                                                                                                                                         |       |                  |       |   |   |
| Preferred  stock, par value $0.001 per share, 10,000,000 authorized, no shares issued or  outstanding                                                                               |       | —                |       | — |   |
| Common  stock, par value $0.001 per share, 40,000,000 shares authorized, 13,488,619  and 13,773,219 shares issued and Outstanding at December 31, 2003 and  2004, respectively |       | 13,489                |       | 13,773 |   |
| Additional  paid-in capital                                                                                                                                                         |       | 671,893               |       | 675,365 |   |
| Retained  deficit                                                                                                                                                                   |       | (416,630              | )          | (216,207 | ) |
| Total  stockholders’ equity                                                                                                                                                    |       | 268,752               |       | 472,931 |   |
| Total  liabilities and stockholders’ equity                                                                                                                                    |       | $                     | 918,278    |   | $ | 971,857 |   |

 

Seeaccompanying notes.

 

32

----

 

**GlobalSCAPE, Inc.**

**ConsolidatedStatements of Operations**

 
| ** **                                                                            | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                            | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| Operating  revenues:                                                                  |       |                                      |       |   |   |   |   |
| Software  product revenues                                                            |       | $                                         | 5,269,503  |   | $ | 4,847,119 |   | $ | 4,930,660 |   |
| Total  revenues                                                                       |       | 5,269,503                                 |       | 4,847,119 |   | 4,930,660 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Operating  expenses:                                                                  |       |                                      |       |   |   |   |   |
| Cost of  revenues (exclusive of depreciation and amortization shown separately below) |       | 353,918                                   |       | 532,910 |   | 371,242 |   |
| Selling,  general and administrative Expenses                                         |       | 3,580,361                                 |       | 3,613,759 |   | 3,456,598 |   |
| Research and  development expenses                                                    |       | 848,212                                   |       | 945,395 |   | 727,423 |   |
| Depreciation  and amortization                                                        |       | 544,063                                   |       | 390,154 |   | 171,834 |   |
| Settlement  with ATSI Comm. Inc.                                                      |       | 392,905                                   |       | — |   | — |   |
| Total  operating expense                                                              |       | 5,719,459                                 |       | 5,482,218 |   | 4,727,097 |   |
| Income  (Loss) from operations                                                        |       | (449,956                                  | )          | (635,099 | ) | 203,563 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                              |       |                                      |       |   |   |   |   |
| Interest  expense                                                                     |       | (8,973                                    | )          | (5,016 | ) | (1,651 | ) |
| Interest  income                                                                      |       | 20,756                                    |       | — |   | — |   |
| Loss on sale  of assets                                                               |       | —                                    |       | (1,486 | ) | — |   |
| Total other  income (expense)                                                         |       | 11,783                                    |       | (6,502 | ) | (1,651 | ) |
| Income  (loss) before income taxes                                                    |       | (438,173                                  | )          | (641,601 | ) | 201,912 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Income tax  provision:                                                                |       |                                      |       |   |   |   |   |
| Current:                                                                              |       |                                      |       |   |   |   |   |
| Federal                                                                               |       | —                                    |       | — |   | — |   |
| State                                                                                 |       | 15,040                                    |       | 1,400 |   | 1,489 |   |
| Deferred:                                                                             |       |                                      |       |   |   |   |   |
| Federal                                                                               |       | 146,932                                   |       | — |   | — |   |
| State                                                                                 |       | 13,230                                    |       | — |   | — |   |
| Total income  tax provision                                                           |       | 175,202                                   |       | 1,400 |   | 1,489 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Net income  (loss)                                                                    |       | $                                         | (613,375   | ) | $ | (643,001 | ) | $ | 200,423 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Net income  (loss) per common share – basic                                      |       | $                                         | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |
| Net income  (loss) per common share - assuming dilution                               |       | $                                         | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |
|                                                                                  |       |                                      |       |   |   |   |   |
| Weighted  average shares outstanding- basic                                           |       | 13,279,263                                |       | 13,361,706 |   | 13,668,800 |   |
| Weighted  average shares outstanding- assuming dilution                               |       | 13,279,263                                |       | 13,361,706 |   | 14,262,796 |   |

 

Seeaccompanying notes.

 

33

----

 

**GlobalSCAPE, Inc.**

**ConsolidatedStatements of Stockholders’ Equity**

** **
| ** **                                                                               | ** ** | **Common Stock** | ** ** | **Additional paid in  Capital** | ** ** | **Retained  Earnings   (Deficit)** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------|------------|---------------------------------|------------|------------------------------------|------------|-----------|------------|
| **Shares**                                                                               | ** ** | **Amount**       |
| Balances at December 31,  2001                                                      |       | 13,022,190       |       | $                               | 13,022     |                               | $          | 707,902   |       | $ | 839,746 |   | $ | 1,560,670 |   |
| Net loss                                                                                 |       | —           |       | —                          |       | —                             |       | (613,375  | )          | (613,375 | ) |
| Exercise of  stock options                                                               |       | 326,429          |       | 327                             |       | 21,811                             |       | —    |       | 22,138 |   |
| Issuance of  common stock                                                                |       | 10,000           |       | 10                              |       | 2,990                              |       | —    |       | 3,000 |   |
| Charges  related to stock options subject to variable accounting                         |       | —           |       | —                          |       | (33,690                            | )          | —    |       | (33,690 | ) |
| Exercise of  stock options for which compensation expense had previously been recognized |       | —           |       | —                          |       | (28,706                            | )          | —    |       | (28,706 | ) |
| Balances at December 31,  2002                                                      |       | 13,358,619       |       | 13,359                          |       | 670,307                            |       | 226,371   |       | 910,037 |   |
| Net loss                                                                                 |       | —           |       | —                          |       | —                             |       | (643,001  | )          | (643,001 | ) |
| Exercise of  options                                                                     |       | 130,000          |       | 130                             |       | 1,586                              |       | —    |       | 1,716 |   |
| Balances at December 31,  2003                                                      |       | 13,488,619       |       | 13,489                          |       | 671,893                            |       | (416,630  | )          | 268,752 |   |
| Net Income                                                                               |       | —           |       | —                          |       | —                             |       | 200,423   |       | 200,423 |   |
| Exercise of  options                                                                     |       | 284,600          |       | 284                             |       | 3,472                              |       | —    |       | 3,756 |   |
| Balances at December 31,  2004                                                      |       | 13,773,219       |       | $                               | 13,773     |                               | $          | 675,365   |       | $ | (216,207 | ) | $ | 472,931 |   |

 

Seeaccompanying notes.

 

34

----

 

**GlobalSCAPE, Inc.**

**ConsolidatedStatements of Cash Flows**

** **
| ** **                                                                              | ** ** | **For the Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                              | ** ** | **2002**                                  | ** ** | **2003** | ** ** | **2004** | ** ** |
| Operating  Activities:                                                                  |       |                                      |       |   |   |   |   |
| Net Income  (Loss)                                                                      |       | $                                         | (613,375   | ) | $ | (643,001 | ) | $ | 200,423 |   |
| Adjustments  to reconcile net loss to net cash provided (used) by operating activities: |       |                                      |       |   |   |   |   |
| Bad debt  expense                                                                       |       | 102,261                                   |       | 14,508 |   | (17,087 | ) |
| Depreciation  and amortization                                                          |       | 544,063                                   |       | 390,154 |   | 171,833 |   |
| Non-cash  compensation                                                                  |       | (59,396                                   | )          | — |   | — |   |
| Loss on  disposition of assets                                                          |       | —                                    |       | 1,486 |   | — |   |
| Deferred  taxes                                                                         |       | 146,932                                   |       | — |   | — |   |
| Changes in  operating assets and liabilities:                                           |       |                                      |       |   |   |   |   |
| Accounts  receivable                                                                    |       | (170,234                                  | )          | (3,354 | ) | 109,167 |   |
| Due from  ATSI, Comm. Inc.                                                              |       | 461,124                                   |       | — |   | — |   |
| Prepaid  expenses                                                                       |       | (52,488                                   | )          | 25,821 |   | (44,716 | ) |
| Accounts  payable                                                                       |       | 61,181                                    |       | 55,660 |   | (58,438 | ) |
| Accrued  expenses                                                                       |       | (56,197                                   | )          | 65,440 |   | (3,281 | ) |
| Deferred  revenue                                                                       |       | 130,422                                   |       | (1,047 | ) | 37,628 |   |
| Other  long-term liabilities                                                            |       | (11,216                                   | )          | (11,215 | ) | (11,215 | ) |
| Net cash  provided (used) by operating activities                                       |       | 483,077                                   |       | (105,548 | ) | 384,314 |   |
| Investing  Activities:                                                                  |       |                                      |       |   |   |   |   |
| Loans to  ATSI Comm. Inc.                                                               |       | (200,000                                  | )          | — |   | — |   |
| Settlement  with ATSI Comm. Inc.                                                        |       | 200,000                                   |       | — |   | — |   |
| Purchase of  property and equipment                                                     |       | (87,822                                   | )          | (73,027 | ) | (42,250 | ) |
| Net cash  used in investing activities                                                  |       | (87,822                                   | )          | (73,027 | ) | (42,250 | ) |
| Financing  Activities:                                                                  |       |                                      |       |   |   |   |   |
| Issuance of  common stock                                                               |       | 22,138                                    |       | 1,716 |   | 3,756 |   |
| Borrowings  under notes payable                                                         |       | —                                    |       | 100,000 |   | — |   |
| Principal  payments on notes payable                                                    |       | —                                    |       | — |   | (100,000 | ) |
| Principal  payments on capital lease obligations                                        |       | (71,321                                   | )          | (61,317 | ) | (15,294 | ) |
| Net cash  provided (used) in financing activities                                       |       | (49,183                                   | )          | 40,399 |   | (111,538 | ) |
| Net increase  (decrease) in cash and cash equivalents                                   |       | 346,072                                   |       | (138,176 | ) | 230,526 |   |
| Cash at  beginning of period                                                            |       | 134,537                                   |       | 480,609 |   | 342,433 |   |
| Cash at end  of period                                                                  |       | $                                         | 480,609    |   | $ | 342,433 |   | $ | 572,959 |   |
| Supplemental  disclosure of cash flow information:                                      |       |                                      |       |   |   |   |   |
| Cash paid  during the year for:                                                         |       |                                      |       |   |   |   |   |
| Interest                                                                                |       | $                                         | 8,973      |   | $ | 4,852 |   | $ | 1,651 |   |
| Income taxes  paid                                                                      |       | $                                         | 21,121     |   | $ | 1,400 |   | $ | 1,489 |   |

** **

See accompanying notes.

** **

**35**

----

 

## **GlobalSCAPE, Inc.**

## **Notes to Consolidated Financial Statements**

###### **December 31,2003 and 2004**

###### ** **

**1.**                                      SignificantAccounting Policies

 

***Corporate Structure***

*** ***

All of theCompany’s operations are conducted by GlobalSCAPE Texas, LP, a Texas limitedpartnership.  The partners of GlobalSCAPETexas, LP are two Nevada limited liability companies, which are both whollyowned subsidiaries of GlobalSCAPE, Inc., a Delaware corporation.  GlobalSCAPE, Inc. was approximately 70%owned by the Brown and Mann-GlobalSCAPE Joint Venture, with the remainder heldpublicly.  In October 2004, theBrown and Mann-GlobalSCAPE Joint Venture began distribution of its GlobalSCAPEstock to its two partners in their respective percentages. At December 31,2004 the partnership held 17,586 shares. GlobalSCAPE, Inc. is a holdingcompany and conducts no operations. The stock of GlobalSCAPE, Inc. isquoted on the OTC Bulletin Board. References to “GlobalSCAPE” or the “Company” refer collectively to allof these entities unless otherwise indicated.

 

***Natureof Business***

* *

GlobalSCAPE,founded in April 1996, develops and distributes Internet relatedsoftware.  The Company is best known forits popular file transfer program, CuteFTP. The Company derives its revenues primarily from sales of licenses to useits software products.  Sales of CuteFTPand CuteFTP Pro accounted for 75% and 69% of total revenues in 2003 and 2004,respectively.  The Company is organizedand operates as one operating segment, the provision of Internet-basedsoftware, and markets its products primarily over the Internet. Secure Serveraccounted for approximately 14% of total revenues in 2004, increasing from 7%of total revenues in 2003.

 

***Basisof Presentation***

* *

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the Unites States requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes.  Actual resultscould differ from those estimates.

 

***Principlesof Consolidation***

* *

Theconsolidated financial statements include all subsidiaries.  All inter-company transactions and balanceshave been eliminated.

 

***Liquidity***

* *

The Companyincurred significant operating losses during 2001, 2002 and 2003 and continued,in January, February and March of 2004, to incur significantoperating losses.  In February 2004GlobalSCAPE reduced its workforce by 20%, laying off 9 of the 45 people thenemployed by the Company.

 

The Company ishighly dependent on the sale of two software products, CuteFTP and CuteFTP Pro,which are subject to technological and competitive obsolescence.  Sales from these two products, whichrepresented 69% of the Company’s revenues in 2004, declined 7% from theprevious year.  This decline wasprimarily in sales of CuteFTP, which declined 36%.  Sales of CuteFTP Pro increased 41% year overyear and sales of Secure Server, the companion product to CuteFTP Pro,increased 106%.  Secure Server accountedfor approximately 14% of total revenues. Substantially all software products ultimately reach a point in theirlifecycle in which sales can be expected to plateau or decline.  While it cannot be determined with certainty,these products may have reached such a point their lifecycles.  Management believes that the market for stand-aloneFTP clients for home consumers may be declining.  However, we

 

36

----

 

have not seen the same decline in the market for secure FTP clients andservers such as CuteFTP Pro and Secure Server which we believe better targetthe needs of businesses.

 

The Company’sliquidity could be reduced in 2005 if sales of CuteFTP continue to decline andthe Company is unable to successfully introduce new products or increase salesof existing products.

 

If sales continueto decline or the Company’s liquidity otherwise requires, management has theintent and ability to reduce personnel and personnel-related costs, reduce orsubstantially eliminate capital expenditures and/or reduce or substantiallyeliminate research and development expenditures.

 

In addition,the Company could draw on its $250,000 line of credit, if necessary.  This line of credit, which matured in December 2004,has been renewed through March 2006. The interest rate is subject to change and is indexed to the bank’sprime rate.  The rate was 7.25% at December 31,2004.  In connection with the line ofcredit, GlobalSCAPE entered into a commercial security agreement with the bankwhereby GlobalSCAPE granted a security interest in all its accounts receivableand property and equipment.  The Companyborrowed $100,000 on September 11, 2003 under this agreement.  This amount remained outstanding as of December 31,2003 but was repaid in February 2004. The credit facility is available to the Company at any point during itsterm.

 

The Company’sflexibility in reacting to changes in the operating environment and to changingeconomic conditions may be limited by the Company’s liquidity position.  However, management believes that, ifrequired, it will be able to effect some or all of the components of the planset forth above, which are sufficient in the aggregate to enable the Company tocontinue as a going concern through at least December 31, 2005.  Accordingly, the financial statements of theCompany do not include any adjustments to reflect the possible future effectsor the recoverability and classification of assets or the amounts andclassification of liabilities that may result if the Company cannot continue tooperate as a going concern.

 

***RevenueRecognition***

* *

The Companyrecognizes revenue in accordance with the American Institute of CertifiedPublic Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

 

Revenues fromthe sale of software products are recognized and completely earned uponshipment or electronic delivery of the product provided that persuasiveevidence of an arrangement exists, collection is probable, payment terms arefixed and determinable and no significant obligations remain.

 

The Companyalso sells technical support and maintenance agreements (post contract customersupport “PCS”), which are sometimes bundled with the software.  When vendor specific objectiveevidence (“VSOE”) of fair value exists for all elements in a multiple elementarrangement, revenue is allocated to each element based on the relative fairvalue of each of the elements. VSOE of fair value is established by the pricecharged when the same element is sold separately.  In a multiple element arrangement wherebyVSOE of fair value of all undelivered elements exists but VSOE of fair valuedoes not exist for one or more delivered elements, revenue is recognized usingthe residual method. Under the residual method, the fair value of theundelivered elements is deferred and the remaining portion of the arrangementfee is recognized as revenue, assuming collection is probable.  Revenue allocated to PCS is recognizedratably over the contractual term, typically one year.

 

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001.  In 2004,sales of enterprise class products resulted in higher maintenance and supportagreements sold to customers and as a result deferred revenue at December 31,2004 was $178,117.

 

The outboundshipping charges charged to the customer are included in software productrevenues and amounted to $57,000, $58,000 and $38,000 in 2002, 2003 and 2004,respectively.  The costs associated withthese shipping charges are included in the software products cost of revenue.

 

37

----

 

***RoyaltyCosts***

* *

Royalties thatthe Company pays on software products licensed from third parties, which itresells, are expensed as a cost of sales when the software product is sold orearlier if the recoverability of any prepaid royalties is in doubt.  The Company has distribution agreements withHannon Hill Corp., Trellix Corp., Perseus Development Corp., Beehive Software, Inc.,Visicom Media, Inc., and Turillion Software Technologies.  The GlobalSCAPE software products associatedwith each of the companies are PureCMS, CuteSITE Builder, Web Survey, Mac FTP,CuteHTML Pro and Protect IIS, respectively. GlobalSCAPE no longer distributes the Protect IIS product and expensedprepaid royalties of approximately $15,000 in December 2003.  GlobalSCAPE’s agreement with Hannon HillCorp. required a minimum royalty of $16,667 per month, as prepayment ofroyalties, for 12 months beginning in December 2002.  These payments were expensed as paid becausethe lower than expected sales of PureCMS raised doubt as to the realization ofbenefit from these prepayments.  Thetotal amount expensed in 2003 relating to these prepayments was $183,337.  The Company accrued approximately $36,500,$36,000, and $11,000 in royalty expense in 2002, 2003 and 2004, respectively.

 

***Concentrationsof Credit Risk and Significant Customers***

* *

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of cash and cash equivalents, and accountsreceivable.  Cash is deposited in demand accounts infederally insured domestic institutions to minimize risk.******TheCompany provides credit, in the normal course of business, to a number ofcompanies and performs ongoing evaluations of its credit risk.  The Company requires no collateral from itscustomers.  Management estimates theallowance for uncollectible accounts based on their historical experience andcredit evaluation.  No single customeraccounted for more than 2% of revenues in 2002, 2003 or 2004.

 

Cash and cash equivalents,accounts receivable, employee advances, accounts payable, accrued expenses andnotes payable, related party are reflected in the accompanying financialstatements at cost, which approximates fair value because of the short termmaturity of these instruments.

 

***OtherConcentrations***

* *

*Sales in Foreign Markets. *In2002, 2003 and 2004, approximately 38%, 35% and 36%, respectively, of theCompany’s revenues were generated from sales to customers who providedaddresses in foreign countries.  However,all revenues are received in U.S. dollars so there is no exchange rate riskwith respect to the sale of our products. These sales were concentrated mostly in Western Europe, Canada, andAustralia.  In 2002, 2003 and 2004, theUK accounted for approximately 11.4%, 11.1% and 10.9%, respectively, of totalrevenues.

 

*Labor. *GlobalSCAPEutilizes offshore developers for a large portion of the coding phase ofsoftware development.  If GlobalSCAPEwere unable to continue using these developers because of political or economicinstability, GlobalSCAPE may have difficulty finding comparably skilleddevelopers or may have to pay considerably more for the same work, which wouldhave a material adverse impact on results of operations.

 

***AdvertisingCosts***

* *

The Companyexpenses advertising costs as incurred. Advertising expenses charged to operations for the years ended December 31,2002, 2003 and 2004 were approximately $300,000, $542,000 and $205,000,respectively, and are included in selling, general and administrativeexpenses.  The advertising expenses in2002 and 2003 relate primarily to the PureCMS product launch.  In 2004, the Company incurred advertisingcost principally for the purchase of keywords for internet searches, a directmail campaign for EFT and advertising in various publications.

 

38

----

 

***IncomeTaxes***

* *

The Companyaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liabilitymethod provides that the deferred tax assets and liabilities are recorded basedon the difference between the tax bases of assets and liabilities and theircarrying amount for financial reporting purposes, as measured by the enactedtax rates and laws that will be in effect when the differences are expected toreverse.  Deferred tax assets are carriedon the balance sheet with the presumption that they will be realizable infuture periods when pre-tax income is generated.  Predicting the ability to realize theseassets in future periods requires a great deal of judgment by management.   Although GlobalSCAPE has generated pre-taxincome in previous years and in 2004, pre-tax losses occurred in 2001, 2002 and2003.  It is our judgment that we cannotpredict with reasonable certainty that the tax assets resulting from theselosses will be fully realized in future periods.  Statement of Financial AccountingStandards (SFAS) No. 109 requires a valuation allowance to reduce thedeferred tax assets reported if, based on the weight of the evidence, it ismore likely than not that some portion or all of the deferred tax assets willnot be realized.  After consideration of all of the evidence, bothpositive and negative, management determined that a $484,350 valuationallowance at December 31, 2004 was necessary to reduce the deferred taxassets to the amount that will more likely than not be realized.  Thechange in the valuation allowance for the current year is a net decrease of $55,497. At December 31, 2004, the Company has available net operating losscarryforwards of approximately $1,249,000, which expire beginning in the year2020.

 

***Researchand Development***

* *

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological feasibility is achieved.For the years 2002, 2003 and 2004, we spent approximately $848,000, $945,000and $728,000, respectively, on research and development.  Typically technological feasibility isachieved very late in the development cycle and as such no research anddevelopment expenses were capitalized in 2002, 2003 or 2004 and all previouslycapitalized research and development expenses were fully amortized at December 31,2002.

 

***Stock-BasedCompensation***

* *

Statement ofFinancial Accounting Standards 123, *Accountingfor Stock-Based Compensation* (SFAS 123), encourages, but does not require, companies to recordcompensation cost for stock-based employee compensation plans based on the fairmarket value of options granted. The Company chose to account for stock basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price.  On December 31,2002, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standard 148, *Accountingfor Stock Based Compensation - Transition and Disclosure* (SFAS 148),which amends SFAS 123.  SFAS 148 requiresmore prominent and frequent disclosures about the effects of stock-basedcompensation. The Company has continued to account for its stock-basedcompensation using the intrinsic value method according to the provisions ofAPB Opinion No. 25.

 

Pro formainformation regarding net income and earnings per share is required byStatement 148, which also requires that the information be determined as if theCompany had accounted for its stock options granted subsequent to December 31,1994 under the fair value method of that Statement.  The fair value of these options was estimatedat the date of grant using a Black-Scholes option-pricing model.

 

39

----

 

For purposesof pro forma disclosures, the estimated fair value of the options at the grantdate  is amortized to expense over theoptions’ estimated vesting period.  TheCompany’s pro forma information for 2002, 2003 and 2004 follows:

 
| ** **                                                                                                                                                                                         | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **2002**                          | ** ** | **2003** | ** ** | **2004** | ** ** |
| Net income  (loss), as reported                                                                                                                                                                    |       | $                                 | (613,375   | ) | $ | (643,001 | ) | $ | 200,423 |   |
| Stock based compensation included in the  determination of net income (loss) as reported, net of related tax effects                                                                               |       | (59,396                           | )          | — |   | — |   |
| Stock-based  compensation expense that would have been included in the determination of  net income (loss) had the fair value based method been applied to all awards,  net of related tax effects |       | (103,923                          | )          | (48,057 | ) | (19,639 | ) |
| Pro forma  net income (loss)                                                                                                                                                                       |       | $                                 | (776,694   | ) | $ | (691,058 | ) | $ | 180,784 |   |
|                                                                                                                                                                                               |       |                              |       |   |   |   |   |
| Earnings  (loss) per share:                                                                                                                                                                        |       |                              |       |   |   |   |   |
| Basic- as  reported                                                                                                                                                                                |       | $                                 | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |
| Basic- pro  forma                                                                                                                                                                                  |       | $                                 | (0.06      | ) | $ | (0.05 | ) | $ | 0.00 |   |
|                                                                                                                                                                                               |       |                              |       |   |   |   |   |
| Diluted- as  reported                                                                                                                                                                              |       | $                                 | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |
| Diluted- pro  forma                                                                                                                                                                                |       | $                                 | (0.06      | ) | $ | (0.05 | ) | $ | 0.00 |   |

 

The weightedaverage fair value of the individual stock options granted during 2002, 2003,and 2004 is estimated at $0.13, $0.20 and $0.15, respectively, on the date ofgrant.  The fair values were determinedusing a minimum value options-pricing model with the following assumptions:

 
| ** **               | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend  yield          |       | None     |       | None     |       | None     |       |
|                     |       |     |       |     |       |     |       |
| Expected  volatility     |       | 2.45     |       | 2.23     |       | 1.64     |       |
|                     |       |     |       |     |       |     |       |
| Risk-free  interest rate |       | 1.82     | %          | 3.21     | %          | 4.24     | %          |
|                     |       |     |       |     |       |     |       |
| Expected  life           |       | 5.0      |       | 5.0      |       | 5.0      |       |

 

***Cash***

* *

Cash includesall cash and highly liquid investments with original maturities of three monthsor less.

 

***Propertyand Equipment***

* *

Property andequipment is comprised of furniture and fixtures, software, computer equipmentand leasehold improvements which are recorded at cost and depreciated using thestraight-line method over their estimated useful lives.  Expenditures for maintenance and repairs arecharged to operations as incurred.  Propertyand equipment acquired under capital leases are depreciated over their usefullives or the respective lease term, if shorter. Depreciation periods used for property and equipment range from three tofive years.

 

Leaseholdimprovements are depreciated over the shorter of the lease term or theestimated useful life of the asset.

 

40

----

 

***Sale / Disposal of Assets***

*** ***

During 2004the Company disposed of equipment and software with an original purchase priceof $31,494 and accumulated depreciation of $31,494.  GlobalSCAPE recognized no gain or lossrelated to the disposal of these assets. During 2003 the Company disposed of equipment and software with anoriginal purchase price of $69,738 and accumulated depreciation of$68,252.  GlobalSCAPE recognized a lossof $1,486 related to the disposal of these assets. There were no disposals offixed assets during 2002.

 

***CapitalizedSoftware Development Costs***

* *

Capitalizationof software development costs begins upon the establishment of technologicalfeasibility and ceases when the product is available for general release. Theestablishment of technological feasibility and the ongoing assessment ofrecoverability of capitalized software development costs require considerable judgmentby management concerning certain external factors including, but not limitedto, technological feasibility, anticipated future gross revenue, estimatedeconomic life and changes in software and hardware technologies.  Amortization expense for these costs amountedto approximately $51,000 in 2002.  Thesesoftware development costs were amortized using the straight-line method over athree-year period and are only those costs incurred in the development of productsthat are sold to external customers and not used for internal purposes. Thesesoftware development costs are not related to those costs incurred for theacquisition of software products or titles. For the years 2002, 2003 and 2004, we spent approximately $848,000,$945,000 and $728,000, respectively, on research and development.  No research and development expenses werecapitalized in 2002, 2003 or 2004 and all previously capitalized research anddevelopment expenses were fully amortized at December 31, 2002.

 

***OtherLong-Term Assets***

* *

Costs incurredfor the acquisition of CuteFTP were capitalized and amortized over theestimated useful life of five years using the straight-line method.  The Core Software Technology on the balancesheet represents the purchase of the source code and related trademark forCuteFTP and the related amortization of these costs.  GlobalSCAPE recognized amortization expenserelated to CuteFTP of approximately $180,000 and $135,000 in 2002 and 2003,respectively.  The asset was fullyamortized at December 31, 2003.

 

Other assetsinclude deposits for facilities, which are anticipated to be refunded to theCompany upon termination of the lease.

 

***OtherLong-Term Liabilities***

* *

Otherlong-term liabilities relate to deferred payments of rent expense.  The total amount of base leasepayments is being charged to expense on the straight-line method over the termof the lease.

 

41

----

 

***EarningsPer Common Share***

* *

Basic anddiluted net income per common share is presented in conformity with Statementof Financial Accounting Standards No. 128, *Earnings Per Share* (SFAS 128) for all periodspresented.  Basic earnings per share isbased on the weighted effect of all common shares issued and outstanding, andis calculated by dividing net income (loss) available to common stockholders bythe weighted average shares outstanding during the period.  Diluted earnings per share is calculated bydividing net income (loss) available to common stockholders by the weightedaverage number of common shares used in the basic earnings per sharecalculation plus the number of common shares that would be issued assumingconversion of all potentially dilutive common shares outstanding.  Below is a reconciliation of the numeratorsand denominators of basic and diluted earnings per share for each of thefollowing years:

 
| ** **                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **2002 (1)**                     | ** ** | **2003 (2)** | ** ** | **2004 (3)** | ** ** |
| **Numerators**                                                |       |                             |       |   |   |   |   |
| ** **                                                    |       |                             |       |   |   |   |   |
| Numerator  for basic and diluted earnings per share:          |       |                             |       |   |   |   |   |
|                                                          |       |                             |       |   |   |   |   |
| Net income  (loss)                                            |       | $                                | (613,375   | ) | $ | (643,001 | ) | $ | 200,423 |   |
|                                                          |       |                             |       |   |   |   |   |
| **Denominators**                                              |       |                             |       |   |   |   |   |
| ** **                                                    |       |                             |       |   |   |   |   |
| Denominators  for basic earnings per share:                   |       |                             |       |   |   |   |   |
|                                                          |       |                             |       |   |   |   |   |
| Weighed  average shares outstanding-Basic                     |       | 13,279,263                       |       | 13,361,706 |   | 13,668,800 |   |
|                                                          |       |                             |       |   |   |   |   |
| **Dilutive  potential common shares:**                        |       |                             |       |   |   |   |   |
| ** **                                                    |       |                             |       |   |   |   |   |
| Stock  Options                                                |       | —                           |       | — |   | 593,996 |   |
|                                                          |       |                             |       |   |   |   |   |
| Denominator  for dilutive earnings per share                  |       | 13,279,263                       |       | 13,361,706 |   | 14,262,796 |   |
|                                                          |       |                             |       |   |   |   |   |
| Net income  (loss) per common share                           |       | $                                | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |
|                                                          |       |                             |       |   |   |   |   |
| Net income  (loss) per commons share – assuming dilution |       | $                                | (0.05      | ) | $ | (0.05 | ) | $ | 0.01 |   |

 

----

*(1)*          For the year ended December 31,2002, 2,965,671 options have not been included in dilutive shares as the effectwould be anti-dilutive.

* *

*(2)*          For the year ended December 31,2003, 1,856,171 options have not been included in dilutive shares as the effectwould be anti-dilutive.

* *

*(3)*          For the year ended December 31,2004, 882,000 options have not been included in dilutive shares as the effectwould be anti-dilutive.

 

***Recent Accounting Pronouncements***

*** ***

***VariableInterest Entities***

*** ***

On January 1,2003, the Financial Accounting Standards Board issued Financial AccountingStandards Board Interpretation No. 46, Consolidation of Variable InterestEntities (“FIN 46”).  FIN 46 addressesconsolidation of business enterprises of variable interest entities.  FIN 46 is effective immediately for allvariable interest entities created after January 31, 2003 and for thefirst fiscal year or interim period ending after December 15, 2003 forvariable interest entities in which an enterprise holds a variable interestthat it acquired before February 1, 2003. The Company has no variable interest entities, therefore, adoption ofthis statement did not impact the Company’s financial position or results ofoperations.

 

42

----

 

***StockOptions***

*** ***

InDecember 2004, FASB issued Statement No. 123-R, *Share-Based Payment,*which establishesaccounting standards for transactions in which an entity receives employeeservices in exchange for (a) equity instruments of the entity or (b) liabilitiesthat are based on the fair value of the entity’s equity instruments or that maybe settled by the issuance of equity instruments*. *Effective in thethird quarter of 2005, SFAS 123-R will require us to recognize thegrant-date fair value of stock options and equity based compensation issued toemployees in the statement of operations. The statement also requires that such transactions be accounted forusing the fair –value-based method, thereby eliminating use of the intrinsicvalue method of accounting in APB No. 25, *Accountingfor Stock Issued to Employees,*which was permitted under Statement123, as originally issued.  We currentlyare evaluating the impact of Statement 123-R on our financial conditionand results of operations.

 

**2.**                                      AccountsReceivable

 

Accountsreceivable, which are primarily from sales of software licenses, are presentednet of an allowance for doubtful accounts. The activity of the Company’s allowance for doubtful accounts for the yearsended December 31, 2002, 2003 and 2004 is presented in the followingtable:

 
| **Balance at**       | ** ** | **Charged to** | ** ** | ** **    | ** ** | **Balance at**     | ** ** |
|----------------------|------------|----------------|------------|---------------|------------|--------------------|------------|
| **Year Ended**       | ** ** | **Beginning**  | ** ** | **Income or** | ** ** | ** **         | ** ** | **End of** | ** ** |
| **December 31** | ** ** | **of Period**  | ** ** | **Expense**   | ** ** | **Deductions (1)** | ** ** | **Period** | ** ** |
|                 |       |           |       |          |       |               |       |   |   |
| 2002                 |       | $              | 25,104     |          | $          | 102,261            |       | $ | (68,938 | ) | $ | 58,427 |   |
| 2003                 |       | 58,427         |       | 14,508        |       | (29,354            | )          | 43,581 |   |
| 2004                 |       | 43,581         |       | (17,087       | )          | (16,299            | )          | 10,195 |   |
|                      |            |                |            |               |            |                    |            |  |  |  |  |  |  |

 

----

(1)  Represents amounts written off as uncollectible accountsreceivable.

 

**3.**                                      Debt

 

The Companyhas obtained a $250,000 revolving line of credit agreement with a commercialbank.  The line of credit expired in December 2004,when it was renewed and extended through March 2006. The line is due ondemand, but if no demand then in March 2006.  The interest rate is subject to change and isindexed to the bank’s prime rate.  Therate at December 31, 2004 was 7.25%. In connection with the line of credit, GlobalSCAPE entered into aCommercial Security Agreement with the bank whereby GlobalSCAPE granted asecurity interest in all its accounts receivable and property andequipment.  The Company borrowed $100,000on September 11, 2003 under this agreement.  This amount remained outstanding as of December 31,2003 and was repaid in February 2004.

 

**4.**                                      Commitmentsand Contingencies

 

**Capital Leases**

 

The Companyhad financed the acquisition of certain fixed assets through capital leaseobligations.  These obligations were paidin full in 2004. As of December 31, 2004 GlobalSCAPE had no capital leaseobligations.

 

Property andequipment at December 31, 2003 and 2004 includes $227,000 for assets heldunder capital leases, less associated accumulated depreciation of $203,000 and$227,000, respectively.  Depreciation forassets held under capital leases is included in depreciation and amortization expense.

 

43

----

 

**Operating Leases**

 

Minimum futurelease payments on non-cancelable operating leases for office facilities are asfollows for the years ending December 31:

 
| 2005       |   | 190,659 |    |
|------------|--------|---------|---------|
| 2006       |   | 190,659 |    |
| 2007       |   | 190,659 |    |
| Thereafter |   | 95,329  |    |
|       |   | $       | 667,306 |   |
|            |        |         |         |  |

 

This leaseprovides the Company with two successive 5-year renewal options.  Operating lease expense amounted toapproximately $180,000 in each of 2002, 2003 and 2004.

 

**Contingencies**

 

TheCompany from time to time may be involved in litigation relating to claimsarising out of its ordinary course of business. There are no pendingclaims against the Company that would have a material adverse effect on thefinancial statements of the Company.

 

**5.**                                      RelatedParty Transactions

 

On June 11,2002, ATSI sold its majority interest in GlobalSCAPE, Inc. to Brown andMann-GlobalSCAPE Joint Venture, a Texas general partnership owned by SanAntonio-based investors Thomas W. Brown and David L. Mann.  Contemporaneously with this transaction,GlobalSCAPE agreed to compromise and settle a $612,304 inter-company balanceowed to it by ATSI, which resulted in charges to GlobalSCAPE of  $392,905. The balance was settled for (i) $200,000 in cash from ATSI; (ii) NTFCCapital Corporation’s release of GlobalSCAPE as a co-borrower on a capitallease executed by ATSI in 1999, and (iii) ATSI’s agreement to provide$50,000 worth of transition support services to GlobalSCAPE over the ninemonths ending March 11, 2003, including payroll administration andGlobalSCAPE’s continued use of a shared accounting platform.  However, the Company completed its transitionfrom ATSI’s payroll and accounting systems during the third quarter of 2002 andexpensed the remainder of the support services, approximately $46,000, duringthe third quarter of 2002.  In addition,prepaid insurance coverage under a joint policy with ATSI was lost toGlobalSCAPE as a result of the change in control, resulting in a charge againstGlobalSCAPE’s prepaid assets of $27,083 during the second quarter of 2002.

 

During theperiod from January 1, 2002 to June 11, 2002, ATSI incurred variousexpenses for the joint benefit of ATSI and GlobalSCAPE such as premiums forhealth and general business insurance. ATSI allocated a portion of these expenses to GlobalSCAPE based onGlobalSCAPE’s proportionate use of the services.  The amounts allocated to GlobalSCAPE were notnecessarily indicative of the amounts that would have been incurred ifGlobalSCAPE had acquired these services on its own, nor of the amounts thatwill be charged in the future.  However,management believes the method of allocation was reasonable.  Expenses for these services in the amount of$40,131 for the period beginning January 1, 2002 and ending June 11,2002 were charged to GlobalSCAPE by ATSI and are reflected in the statement ofoperations.  Also during 2002, theCompany made various loans to ATSI with interest of 12% per annum.

 

On June 21,2002, GlobalSCAPE, Inc. announced the termination of its CEO, TimNicolaou.  Mr. Nicolaou resignedfrom the Board of Directors and received $190,000 in severance payments asprovided by his employment agreement and continued to receive health benefitspaid by the Company for a period not to exceed twelve months, the cost of whichwas expensed in 2002.

 

On March 30,2004, the Company obtained a $200,000 line of credit with the Brown andMann-GlobalSCAPE Joint Venture.  The lineof credit was available after June 21, 2004 if the Company failed toextend a line of credit with a bank and matured on December 31, 2004.  The line of credit with the partnership wasnot renewed.  The interest rate wassubject to change and was indexed to the prime rate published in the WallStreet Journal.  In connection with theline of credit, GlobalSCAPE entered into a

 

44

----

 

Commercial Security Agreement with the Brown and Mann-GlobalSCAPE JointVenture whereby GlobalSCAPE granted a security interest in all its accountsreceivable and property and equipment.  ** **TheBrown and Mann-GlobalSCAPE Joint Venture is 70% owned by Thomas W. Brown and30% owned by David L. Mann, both of whom are members of GlobalSCAPE’s Board ofDirectors. In October 2004 the Brown and Mann-GlobalSCAPE Joint Venturedistributed all shares held by the partnership to its two partners with theexception of 17,856 shares.

 

**6.  Income Taxes**

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of the Company’s deferred tax assets andliabilities are related to the following:

 
| ** **                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Total  deferred tax liabilities              |       | $        | —     |     | $          | — |   |
|                                         |       |     |       |     |       |
| Deferred tax  assets:                        |       |     |       |     |       |
| Accrued  expenses                            |       | 29,292   |       | —   |       |
| Allowance  for doubtful accounts             |       | 15,428   |       | 3,466    |       |
| Deferred  revenue                            |       | 47,766   |       | —   |       |
| Depreciation  and amortization               |       | 17,305   |       | 56,696   |       |
| Net  operating loss carryforwards            |       | 430,559  |       | 424,691  |       |
| Total  deferred tax assets                   |       | 540,350  |       | 484,853  |       |
| Valuation  allowance for deferred tax assets |       | 540,350  |       | 484,853  |       |
| Net deferred  tax assets                     |       | $        | —     |     | $          | — |   |

 

Areconciliation of income tax expense and the amount computed by applying thestatutory federal income tax rate (34%) to income before income taxes is asfollows:

 
| ** **                                                  | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Taxes  computed at federal statutory rate                   |       | $        | (148,986   | )        | $          | (218,620 | )          | $ | 68,655 |   |
| Increases  (decreases) in taxes resulting from:             |       |     |       |     |       |     |       |
| State taxes,  net of federal benefit                        |       | 18,658   |       | 924      |       | 983      |       |
| Non-deductible  incentive stock option compensation charges |       | (21,215  | )          | —   |       | —   |       |
| Other  non-deductible expenses                              |       | 2,800    |       | 2,581    |       | 2,368    |       |
| Change in  valuation allowance                              |       | 323,835  |       | 216,515  |       | (55,497  | )          |
| Other                                                       |       | 110      |       | —   |       | (15,020  | )          |
| Total                                                       |       | $        | 175,202    |     | $          | 1,400    |       | $ | 1,489 |   |

 

At December 31,2004, the Company has available net operating loss carryforwards ofapproximately $1,249,000, which expire beginning in the year 2020.

 

**7.**                                      EmployeeBenefit Plan

 

The Companyhas a 401(k) plan that covers substantially all employees with at least sixmonths of service.  Under the plan,employees may elect to contribute a percentage of their annual salary subjectto the Internal Revenue Code maximum limitations.  The plan provides for employer matching anddiscretionary contributions, the amounts of which are to be determined annuallyby the Board of Directors.  The Companymade contributions to the plan of $7,347, $7,533 and $6,910 for the years endedDecember 31, 2002, 2003 and 2004, respectively.

 

45

----

 

**8.**                                      StockOptions and Stock Based Compensation

 

In January 1998,the Company approved the 1998 Stock Option Plan (the “1998 Plan”) for officers,other employees, directors, and consultants of the Company.  Under the terms of the 1998 Plan, up to 728,571shares of the Company’s common stock may be granted in the form of incentivestock options or non-qualified stock options, awarded, or sold to officers,other employees, directors and consultants. As of July 31, 2001, no additional grants could be issued under the1998 Plan.

 

In May 2000,the Board of Directors approved the 2000 stock option plan (the “2000 Plan”)for key employees, non-employee directors, and advisors of the Company.  Under the terms of the 2000 Plan, up to3,660,000 shares of the Company’s common stock may be granted in the form ofincentive stock options or non-qualified stock options.  The maximum aggregate number of shares ofcommon stock that may be granted to any optionee during the term of the 2000Plan may not exceed 2,000,000.  The 2000Plan provides that the purchase price per share for incentive stock options andnon-qualified stock options shall not be less than the fair market value of thecommon stock on the date of grant.  Themaximum term for an option granted is ten years from the date of grant.

 

The Companyhas adopted Statement of Financial Accounting Standards No. 123, “Accountingfor Stock Based Compensation” (SFAS No. 123), and elected to use theintrinsic value method in accounting for its stock option plan in accordancewith Accounting Principles Board opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations under which compensationexpense is recorded to the extent that the current market price of theunderlying stock exceeds the exercise price. No options were issued below fair value for the years ended December 31,2003 and 2004.

 

During thesecond, third and fourth quarters of 2004, 261,000, 105,000 and 215,000 optionswere granted to various employees at an average exercise price of $0.15 pershare.

 

**Supplemental Disclosures for Stock Options**

 

The followingtable shows the number of options granted, cancelled and exercised for alloption plans for the three years ending December 31, 2004.

 
| ** **                          | ** ** | **Number of** | ** ** | **Weighted Avg.**  | ** ** |
|-------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                          | ** ** | **Shares**    | ** ** | **Exercise Price** | ** ** |
| 2002                                | ** ** | ** **    | ** ** | ** **         | ** ** |
| Outstanding December 31,  2001 |       | 3,557,480     |       | $                  | 0.41       |   |
| Granted                             |       | 24,000        |       | 0.13               |       |
| Expired                             |       | 289,380       |       | 0.79               |       |
| Exercised                           |       | 326,429       |       | 0.07               |       |
| Outstanding December 31,  2002 |       | 2,965,671     |       | 0.40               |       |
|                                |       |          |       |               |       |
| 2003                                |       |          |       |               |       |
| Granted                             |       | 56,000        |       | 0.20               |       |
| Expired                             |       | 1,035,500     |       | 0.72               |       |
| Exercised                           |       | 130,000       |       | 0.0132             |       |
| Outstanding December 31,  2003 |       | 1,856,171     |       | 0.2454             |       |
|                                |       |          |       |               |       |
| 2004                                |       |          |       |               |       |
| Granted                             |       | 581,000       |       | 0.15               |       |
| Expired                             |       | 182,500       |       | 0.28               |       |
| Exercised                           |       | 284,600       |       | 0.0132             |       |
| Outstanding December 31,  2004 |       | 1,970,071     |       | $                  | 0.2474     |   |

 

46

----

 

The followingtable shows information about outstanding stock options at December 31,2004.

 
| ** **                    | ** ** | ** **               | ** ** | **Options Outstanding**                             | ** ** | **Options Exercisable**                | ** ** |
|-------------------------------|------------|--------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $ 0.0132                      |       | 565,571                  |       | 5.89                                                |       | $                                      | 0.0132     |   | 565,571 |   | $ | 0.0132 |   |
| $ 0.12 - $0.20                |       | 548,500                  |       | 9.59                                                |       | 0.151                                  |       | 8,580 |   | 0.200 |   |
| $ 0.464                       |       | 856,000                  |       | 6.29                                                |       | 0.464                                  |       | 856,000 |   | 0.464 |   |
| $ 0.0132 - $0.464             |       | 1,970,071                |       | 7.09                                                |       | $                                      | 0.2474     |   | 1,430,151 |   | $ | 0.2841 |   |
|                               |            |                          |            |                                                     |            |                                        |            |  |  |  |  |  |  |  |  |

 

**9.**                                      QuarterlyFinancial Information (unaudited)

 
| ** **                                           | ** ** | **Fiscal Year 2003** | ** ** |
|------------------------------------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **1st Quarter**      | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                                 |       |                 |       |   |   |   |   |   |   |
| Total  revenues                                      |       | $                    | 1,120,186  |   | $ | 1,309,708 |   | $ | 1,336,682 |   | $ | 1,080,543 |   |
| Total  operating expenses                            |       | 1,727,968            |       | 1,207,219 |   | 1,251,682 |   | 1,295,349 |   |
| Net income  (loss) before provision for income taxes |       | (610,416             | )          | 101,582 |   | 83,984 |   | (216,751 | ) |
| Net income  (loss)                                   |       | (610,416             | )          | 101,582 |   | 82,584 |   | (216,751 | ) |
|                                                 |       |                 |       |   |   |   |   |   |   |
| Net income  (loss) per share:                        |       |                 |       |   |   |   |   |   |   |
| Basic                                                |       | $                    | (0.05      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | (0.02 | ) |
| Diluted                                              |       | $                    | (0.05      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | (0.02 | ) |
| Weighted  average shares outstanding:                |       |                 |       |   |   |   |   |   |   |
| Basic                                                |       | 13,358,619           |       | 13,358,619 |   | 13,358,619 |   | 13,370,902 |   |
| Diluted                                              |       | 13,358,619           |       | 14,284,107 |   | 14,275,292 |   | 13,370,902 |   |
|                                                      |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                           | ** ** | **Fiscal Year 2004** | ** ** |
|------------------------------------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **1st Quarter**      | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                                 |       |                 |       |   |   |   |   |   |   |
| Total  revenues                                      |       | $                    | 1,172,137  |   | $ | 1,287,797 |   | $ | 1,270,223 |   | $ | 1,200,502 |   |
| Total  operating expenses                            |       | 1,377,737            |       | 1,083,595 |   | 1,135,252 |   | 1,133,651 |   |
| Net income  (loss) before provision for income taxes |       | (205,600             | )          | 204,202 |   | 134,971 |   | 66,851 |   |
| Net income  (loss)                                   |       | (205,600             | )          | 204,202 |   | 134,971 |   | 66,851 |   |
|                                                 |       |                 |       |   |   |   |   |   |   |
| Net income  (loss) per share:                        |       |                 |       |   |   |   |   |   |   |
| Basic                                                |       | $                    | (0.02      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
| Diluted                                              |       | $                    | (0.02      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | 0.00 |   |
| Weighted  average shares outstanding:                |       |                 |       |   |   |   |   |   |   |
| Basic                                                |       | 13,488,619           |       | 13,638,995 |   | 13,773,219 |   | 13,773,219 |   |
| Diluted                                              |       | 13,488,619           |       | 14,154,174 |   | 14,303,786 |   | 14,367,215 |   |

 

47

----

 

In the firstquarter of 2003, GlobalSCAPE spent approximately $460,000 on the PureCMSproduct launch.  In the fourth quarter of2003, revenues were approximately $242,000, or 18%, lower than the same quarterin the previous year.  Comparisons ofGlobalSCAPE’s quarterly results from operations should take these items intoconsideration.

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

On September 16,2004 GlobalSCAPE, Inc. dismissed Ernst & Young LLP as itsindependent auditor. Also, on September 16, 2004 it named Helin, Donovan,Trubee & Wikinson, LLP as its independent public accountant for theyear ended December 31, 2004. Each of these actions was approved by theCompany’s Board of Directors

 

# **Item 9A. Controls and Procedures**

#  

As of the endof the period covered by this Annual Report, our President and Chief FinancialOfficer carried out an evaluation of the effectiveness of GlobalSCAPE’sdisclosure controls and procedures (as defined SEC Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended,(the “Exchange Act”)) and concluded that the controls and procedures areeffective in recording, processing, summarizing and reporting the informationrequired to be disclosed by GlobalSCAPE in the reports it files with the SECunder the Exchange Act within the time periods specified in the SEC’s rules andforms.  There has been  no change in our internal controls overfinancial reporting during the most recent fiscal quarter that has  materially affected, or is reasonably likelyto materially affect our internal control over financial reporting.

 

**Item9B.  Other Information**

 

None.

 

48

----

 

# **Part III**

#  

**Item10.  Directors and Executive Officers ofthe Registrant**

 

Theinformation called for by Item 10 of Form 10-K as to Directors isincorporated herein by reference to such information included in our ProxyStatement for the 2005 Annual Meeting of Stockholders. Also see Item 4A of Part Iof this Form 10-K.  Theinformation called for by Item 10 of Form 10-K as to compliance withSection 16(a) of the Exchange Act is incorporated herein by referenceto such information included in our Proxy Statement for the 2005 Annual Meetingof Stockholders.

 

GlobalSCAPE has adopted a Code of Ethics thatapplies to all its employees, including its President (its chief executiveofficer) and its Vice President of Finance and Operations (its chief financialofficer).  GlobalSCAPE will provide a copy of its Code of Ethics to anyperson without charge upon written request to:

 

Thomas F. Farar

Chief Financial Officer

GlobalSCAPE, Inc.

6000 Northwest Parkway, Suite 100

San Antonio, Texas  78249

 

**Item11. Executive Compensation**

 

Theinformation called for by Item 11 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2005 Annual Meeting of Stockholders, except for those parts under the captions “BoardReport on Executive Compensation” and “Report on Repricing of Options”.

 

**Item12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

Theinformation called for by Item 12 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement for the2005 Annual Meeting of Stockholders.

 

**Item 13. Certain Relationships and RelatedTransactions**

 

Theinformation called for by Item 13 of Form 10-K is incorporatedherein by reference to such information included in our Proxy Statement of the2005 Annual Meeting of Stockholders.

 

**Item 14.****Principal Accountant Feesand Services.**

 

Theinformation call for by Item 14 of Form 10-K is incorporated hereinby reference to such information included in our Proxy Statement of the 2005Annual Meeting of Stockholders

 

49

----

 

# **PART IV**

#  

##### **Item 15**.Exhibits, Financial Statement Schedule, and Reports on Form 8-K

##### ** **

(a)(1)                    Financial Statements and Schedules

 

The following financial statements of GlobalSCAPE, Inc. are included in Item 8:

•                  Consolidated balance sheets - December 31, 2003 and 2004

•                  Consolidated statements of operations - Years ended December 31, 2002, 2003 and 2004

•                  Consolidated statements of stockholders’ equity - Years ended December 31, 2002, 2003 and 2004

•                  Consolidated statements of cash flows - Years ended December 31, 2002, 2003 and 2004

•                  Notes to consolidated financial statements - December 31, 2004

 

(2)                      Schedules not listed above have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or Notes thereto.

 

(3)                      Exhibits

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                        |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Certificate of Incorporation of the Company  dated April 17, 1996 (Filed as Exhibit 3.1 to Form 10 filed May 12,  2000).                                                                                           |
| 3.2                 |       | Certificate of Renewal and Revival of  Certificate of Incorporation for the Company dated February 16, 1999  (Filed as Exhibit 3.2 to Form 10 filed May 12, 2000).                                                 |
| 3.3                 |       | Certificate of Amendment of Certificate of  Incorporation dated May 11, 2000 (Filed as Exhibit 3.3 to Form 10  filed May 12, 2000).                                                                                |
| 3.4                 |       | Certificate of Amendment to Certificate of  Incorporation dated September 5, 2000 (Filed as Exhibit 3.5 to Form 10,  Amendment No. 2, filed September 12, 2000)                                               |
| 3.5                 |       | Bylaws of the Company (Filed as Exhibit 3.4  to Form 10 filed May 12, 2000).                                                                                                                                            |
| 3.6                 |       | Amended and Restated Bylaws of the Company  effective as of September 1, 2000 (Filed as Exhibit 3.6 to Form 10,  Amendment No. 2, filed September 12 2000).                                                   |
| 3.7                 |       | Amended and Restated Bylaws of GlobalSCAPE  effective as of October 10, 2000 (Filed as Exhibit 10.1 to Form 8-K  filed October 10, 2000).                                                                          |
| 3.8                 |       | Amended and Restated Bylaws of GlobalSCAPE effective  as of January 30, 2003 (Filed as Exhibit 3.8 to Annual Report on Form 10-K  filed March 31, 2003).                                                           |
| 4.1                 |       | Specimen of Stock Certificate (Filed as Exhibit 4.1  to Annual Report on Form 10-K filed April 2, 2001).                                                                                                                |
| *10.1               |       | 1998 Stock Option Plan as amended May 13,  1999 (Filed as Exhibit 4.2 to Form 10 filed May 12, 2000).                                                                                                              |
| *10.2               |       | 2000 Stock Option Plan dated May 8,  2000 (Filed as Exhibit 4.3 to Form 10 filed May 12, 2000).                                                                                                                    |
| *10.3               |       | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement of Directors to Agree Not to Claim Any Right of  Adjustment dated February 4, 2000 (Filed as Exhibit 4.6 to Form 10  filed May 12, 2000). |
| *10.4               |       | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement for Employees and Consultants to Cancel Options  dated February 8, 2000 (Filed as Exhibit 4.7 to Form 10, filed  May 12, 2000).           |
| *10.5               |       | Form of 1998 Stock Option Plan Rights  Termination Letter of Officer to Agree Not to Claim Any Right of Adjustment  dated February 8, 2000 (Filed as Exhibit 4.8 to Form 10 filed May 12,  2000).             |

 

50

----

 
| *10.6  |   | Form of 1998 Stock Option Plan Rights  Termination Letter Agreement of Officer to Agree Not to Exercise Options  dated February 8, 2000 (Filed as Exhibit 4.9 to Form 10 filed May 12,  2000).                  |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.7  |   | Form of 1998 Stock Option Plan  Reinstatement and Adjustment Letter for Employees dated December 19,  2000 (Filed as Exhibit 10.17 to Annual Report on Form 10-K  filed April 2, 2001).                         |
| *10.8  |   | Form of Release and Indemnity  Agreement between GlobalSCAPE, Inc. and Employees dated December 19,  2000 (Filed as Exhibit 10.18 to Annual Report on Form 10-K  filed April 2, 2001).                     |
| 10.9   |   | Commercial Lease Agreement between ACLP  University Park S.A. II, L.P. and the Company dated April 13, 1999  (Filed as Exhibit 10.1 to Form 10 filed May 12, 2000).                                                  |
| *10.10 |   | Release and Indemnity Agreement between  GlobalSCAPE, Inc. and Sandra Poole-Christal dated April 2, 2001  (Filed as Exhibit 10.17 to Annual Report on Form 10-K filed April 1,  2002).                          |
| *10.11 |   | Granting letter for 808,571 options to  Sandra Poole-Christal under GlobalSCAPE, Inc. 1998 Stock Option Plan  dated April 20, 2001 (Filed as Exhibit 10.18 to Annual Report on Form 10-K  filed April 1, 2002). |
| *10.12 |   | Bonus letter for Sandra Poole-Christal in  connection with grant of 808,571 options under 1998 Stock Option Plan (Filed  as Exhibit 10.19 to Annual Report on Form 10-K filed April 1,  2002).                            |
| *10.13 |   | Incentive Stock Option Agreement between  GlobalSCAPE, Inc. and Sandra Poole Christal dated April 20, 2001  (Filed as Exhibit 10.20 to Annual Report on Form 10-K filed April 1,  2002).                        |
| *10.14 |   | Form of Incentive Stock Option  Agreement under GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.21  to Annual Report on Form 10-K filed April 1, 2002).                                           |
| 21     |   | Subsidiaries (filed herewith).                                                                                                                                                                                                           |
| 23.1   |   | Consent of Helin, Donovan, Trubee &  Wilkinson, LLP (filed herewith).                                                                                                                                                           |
| 23.2   |   | Consent of Ernst & Young LLP  (filed herewith)                                                                                                                                                                                  |
| 31.1   |   | Rule 13a-14(a)/15d - 14(a) Certification  of Charles R. Poole, President and Chief Operating Officer of GlobalSCAPE, Inc.  (filed herewith).                                                                              |
| 31.2   |   | Rule 13a-14(a)/15d - 14(a) Certification  of Thomas F. Farar, Chief Financial Officer (filed herewith).                                                                                                                        |
| 32.1   |   | Certificate pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  (filed herewith).                                                                                      |

 

----

* Management Compensatory Plan or Agreement

 

51

----

 

**Signatures**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in San Antonio, Texas on March 24,2005.

 

 
| ** ** | **GlobalSCAPE, Inc.** | ** **                             |
|------------|----------------------------|----------------------------------------|
| ** ** | ** **                 | ** **                             |
| ** ** | ** **                 | ** **                             |
|       |                       | By:                                    | /s/ Charles R. Poole |   |   |
|       |                       | Charles  R. Poole                      |   |   |
|       |                       | President and Chief  Operating Officer |   |   |
|       |                       |                                   |
|       |                       |                                   |
|       |                       | By:                                    | /s/ Thomas F. Farar |   |   |
|       |                       | Thomas  F. Farar                       |   |   |
|       |                       | Chief Financial Officer                |   |   |
|            |                            |                                        |  |  |  |  |  |  |

 

Pursuant tothe requirements of the Securities Act of 1934, this report has been signedbelow by the following persons on behalf of the registrant in the capacitiesindicated on March 24, 2005.

 

 
| **Signature**        |   | **Title**                                     |
|----------------------|--------|-----------------------------------------------|
|                 |   |                                          |
| /s/ Charles R. Poole |   |                                          | President, COO and Director |
| Charles R. Poole     |   | (Principal Executive Officer)                 |
|                 |   |                                          |
| /s/ Thomas W. Brown  |   |                                          | Chairman of the Board and Director |
| Thomas W. Brown      |   |                                          |
|                 |   |                                          |
| /s/ David L. Mann    |   |                                          | Director |
| David L. Mann        |   |                                          |
|                 |   |                                          |
| /s/ Thomas F. Farar  |   |                                          | Chief Financial Officer, |
| Thomas F. Farar      |   | Treasurer, Secretary                          |
|                 |   | (Principal Accounting and Financial  Officer) |
|                      |        |                                               |  |  |  |  |

 

52

----